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Want to evaluate your company’s cash flow? Learning how to find net cash flow can be a great way to gain insight into the financial health of your business.
But what is net cash flow? Learn the ins and outs of how to calculate net cash flow – as well as the importance and limitations of this handy financial metric – with our definitive guide.
What is net cash flow?
Net cash flow is a profitability metric that represents the amount of money produced or lost by a business during a given period. Usually, you can calculate net cash flow by working out the difference between your business’s cash inflows and cash outflows. Generally speaking, net cash flow is comprised of three categories, which are as follows:
Operating activities – Capital generated and used by your business’s basic operations, including expenditures for administrative expenses and receipts from customers.
Financial activities – Capital generated through debt agreements or cash that’s been issued to pay off debts or pay out dividends.
Investing activities – Capital generated by profitable investments or cash issued to make an investment or purchase fixed assets.
Net cash flow formula
So, how do you calculate net cash flow? It’s a relatively straightforward formula:
This can be put more simply, like so:
How does this work in the real world? Let’s look at an example.
Imagine Company A has a net cash flow from operating activities of £100,000 and a net cash flow from financial activities of £40,000. However, Company A also lost money from investments, resulting in a net cash flow from investing activities of -£60,000. How do you calculate net cash flow for Company A?
This means that Company A’s net cash flow over the given period is £80,000, indicating that the business is relatively strong, and should have enough capital to invest in new products or reduce debts.
Why is net cash flow important?
Learning how to calculate net cash flow can help you determine how much cash your company generates and whether its cash flows are positive or negative, providing you with insight into your short-term financial viability.
Put simply, if your business is consistently able to generate a positive net cash flow, it may have a real chance of succeeding. On the other hand, a business that generates a negative net cash flow, month after month, may be encountering financial or operational issues.
What are the limitations of net cash flow?
Although net cash flow is an excellent barometer of financial health, it’s important to remember that some activities resulting in a positive cash flow may not be good for the business’s overall health. For example, your business may have received an injection of cash after taking on a new debt. This may result in a positive cash flow, but it’s not necessarily ideal for your finances moving forward.
Plus, negative cash flow isn’t always a bad thing. A negative cash flow from investments may indicate that you’ve spent a significant amount of money on an investment that’s going to boost your revenues in the future. For example, while investing in new machinery or real estate may leave you in the red, you can expect to make your money back relatively quickly.
It’s also important not to focus exclusively on net cash flow when calculating your business’s financial viability. There are other financial measurements that you should pay attention to, including changes in your business’ overheads and fluctuations in the level of debt that your business has taken on.
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