How can you measure cash flow?
If you want a quick snapshot of your cash flow, you could compare your company's current bank balance with what it was a month ago. This would only provide a rough measure, but for smaller firms with no major debt or capital investment, it can still be useful.
Tracking this figure back over a period of several months will give you an idea of whether your company's cash flow trend is negative or positive. If the balance is making its way lower – if your cash flow is negative for several months in a row – then that could be a warning sign about the health of your business.
“Some business owners believe their gut is an indicator of the business's performance, and listen to that over maintaining accurate records. The lack of timely accurate record-keeping means the business has minimal understanding of their cash flow situation and in turn lacks the skills or information to manage it.” - Heather Smith, Chartered Accountant
However, there are better ways to measure and analyse your cash flow, especially for more established businesses. Two of the most widely-used measures of cash flow are:
Cash flow from operations
Sometimes called operating cash flow, this takes a zoomed-in snapshot of the business, showing only the cash flow from operational activities. It excludes investment and capital costs, taking earnings before interest and tax (EBIT) and adding depreciation. It's useful for working out the real cash flow of a business that has lots of capital investment or property ownership.
Free cash flow
One of the most common measurements is free cash flow (FCF), sometimes broken down into free cash flow to the firm (FCFf) and free cash flow to equity (FCFe).
Generally speaking, FCF is the flow of money through the business, minus capital expenditures (equipment, mortgages, etc.).
It's a straightforward calculation: take earnings before interest and tax (EBIT) and then subtract capital and related expenditures. This is useful because some cash flow might not actually be 'free' - it may be needed to pay off mortgages or other debts. FCF can give a clearer idea of the cash flow that's actually available to use for investment or other purposes.
There are other metrics available, but depending on the size and scale of your business, these two are likely to tell you the most useful information about your business. Of the two, FCF is likely to be suited to most small to medium-sized businesses. It's a good idea to talk to your accountant to find out more about which method will work best for you.‹ View table of contents Next page ›