What’s Net Cash Flow and How Do You Use It?

If you want to know how money is being utilized within your business, you can look at your net cash flow. It depicts the cash inflows and outflows of your business in a given period. 

But how this metric is calculated? Why is it important to a business? Is it the same thing as net income? These are some commonly asked questions that you too may have about cash flow. In today’s article, we’ll walk you through it!

What is net cash flow?

Net cash flow is a metric that tells you the amount of money that comes in or goes out of your business within a specific period of time. This metric also represents the amount of money produced or lost by a business during a given period. If more cash comes in, the result would be a positive cash flow. On the other hand, your business may see a negative cash flow if more money goes out than comes in. 

Net cash flows can be found in the statement of cash flows. Alternatively, you can determine the amount by calculating the changes in cash balance stated in the balance sheet over two different periods.

Net cash flow is generated through three main activities: operating activities, investing activities, and financing activities. As a result, it’s the aggregate of cash inflows and outflows from these three activities. 

  • Cash from operating activities (CFO): This is the money generated from the business’s core operations. Cash from operating activities comprises funds from operations and changes in working capital. Funds from operations include net incomes, depreciation (an expense converted from a fixed asset as the asset is used during normal business operations), deferred taxes (taxes that are owed but are not due to be paid until a future date), and other funds. Working capital involves current assets and liabilities (accounts payable, account receivable, etc.)
  • Cash from investing activities (CFI): This is the net cash generated from sales and purchase of equipment and assets (tangible or intangible) and any other capital expenditure for core operations. It also includes the movement of cash due to investments made outside the company like investing in other businesses, stock market, etc.
  • Cash from financing activities (CFF): This is the net cash generated from the procurement and repayment of short and long-term debt, issuance of equity, purchase/sale of treasury stock, payment of dividends, etc.

See also: What You Need to Know about Operating Cash Flow Ratio

The net cash flow formula

So, how do you calculate net cash flow? Just use this formula:

Net Cash Flow = Net Cash Flow from Operating Activities + Net Cash Flow from Financing Activities + Net Cash Flow from Investing Activities

It may look complicated, but it’s really simple. Take this real-world example, for instance:  

Company A has a cash flow from operating activities of $90,000 and a cash flow from investing activities of $30,000. However, Company A also has to pay a loan repayment of $20,000, which results in a cash flow from financing activities of -$20,000. 

How can you calculate the net cash flow for Company A? Apply the formula above, and it will look like this:

Net Cash Flow = $90,000 – $20,000 + $30,000 = $100,000

This means that Company A has a $100,000 net cash flow over the given period. A positive cash flow indicates that the financial health of company A is relatively strong. They’re going on the right track, and if they keep up the good work, chances are they’ll be able to grow quickly. 

Why is net cash flow important? 

Net cash flow serves as a gauge to determine your business’ liquidity. As a result, it gives business owners like you insight into the business’s financial health. Having a positive cash flow is a good sign meaning that your business is thriving. On the other hand, having a negative cash flow might indicate that your business is facing trouble.

With that being said, sometimes, a negative cash flow isn’t necessarily a bad sign. For example, if you’ve recently invested a significant amount of money into new equipment, this could lead to a negative cash flow for a period. However, it would boost up your productivity and bring you higher revenue in the future. 

But, as a rule of thumb, positive cash flow is more likely to reflect positive business performance. Positive cash flow opens up opportunities such as being able to invest in research and development or hiring more employees. On the other hand, a negative cash flow may limit your business’s growth. Consequently, you must figure out ways to improve cash flows.  

Is net cash flow the same as net income?

Technically speaking, they aren’t the same. Net income demonstrates the effectiveness of a company’s sales and marketing, resulting in sales volume, while cash flow is more of a liquidity indicator.

Your business can have a high net income but still post a negative cash flow. This is because your income generally considers accounts receivable, but cash flow doesn’t. For example, assume you made a sale for $5,000, but you let your customer pay in 5 months. As a result, the cash flow you gained from the sale would be $1,000 for this month, whereas your income is recorded as $5,000 if your company adopts the accrual accounting method. 

How can you manage cash flow?

As we mentioned above, the net cash flow is the total cash from operating, investing, and financing activities. In contrast to investing and financing activities which may be one-time or sporadic revenue, the operating activities are core to the business and are recurring every month. As a result, this is the main source of most of a business’ money. 

So, if you want to manage your cash flow more effectively, start with cash flow from operating activities. Since cash from operating activities is mainly generated through the sales of goods or services, monitoring your transactions daily will help you better control the cash flow. 

It’s a good practice to match the cash inflow from the sales with sales receipts incurred in a day everyday. By doing so, once you identify a mistake has occurred, you can quickly take action to rectify the issue. It can be less stressful as well. 

Even if you’re a small business, you can generate scores of sales receipts per day. It could take up lots of time if you have to manually calculate all the cash transactions made in a day and cross-reference it with the actual cash you receive.  

To save your time and effort, switch to bookkeeping software that can automatically calculate and make reports out of your receipts. A great software for this is Shoeboxed. All you have to do is get your receipts scanned, stored, and organized. Shoeboxed will make a report out of it for you. 

The bottom line

Net cash flow shows you the bigger picture of your cash inflows and outflows. It lets you know how your business is doing and whether you need to make any changes to it. If you have a positive net cash flow, you’re likely on the right track. On the other hand, a negative cash flow means you may need to reevaluate your strategies.