Cash flow is the backbone of any business. Without a clear picture of your cash inflows and outflows, it’s impossible to make informed business decisions about your company’s future. NorthStar Bookkeeping created this guide to help walk you through the process of how to calculate cash flow.
What is Cash Flow?
Cash flow is the movement of cash both into and out of your business. It provides insight into your company’s ability to meet its financial considerations and plan for growth down the road.
“Cash flow is the single biggest indicator of a company’s financial health,” says Paul Yee, Co-Owner of NorthStar Bookkeeping.
Why is Cash Flow Important?
Maintaining a healthy cash flow is crucial for several reasons:
- Meeting Financial Obligations: You need sufficient cash on hand to pay your bills, including employee wages, rent, and vendor invoices.
- Securing Financing: Banks and other financial institutions often evaluate a company’s cash flow to determine its creditworthiness and growth potential.
- Making Informed Business Decisions: Understanding your cash flow patterns helps you and your business partners make informed decisions about investments, expansion, and hiring.
How to Calculate Cash Flow
Here are the two methods for calculating cash flow:
1. Direct Method
The direct method tracks all cash movement directly from your financial records and bank statements. This method provides a detailed look of where each dollar is at a given time.
2. Indirect Method
The indirect method takes a different approach. It starts with your net income and adjusts for depreciation and amortization. This method is often used for financial reporting.
Steps to Calculate Cash Flow Using the Direct Method
Businesses rely on bookkeeping firms like NorthStar Bookkeeping to keep your financial records in order and accessed anytime, anywhere. Here are three steps we take:
- Gather Your Financial Records: NorthStar organizes your bank statements, sales receipts, invoices, and other relevant financial documents.
- Calculate Cash Inflows: NorthStar adds up all cash received from sales, investments, and other sources.
- Calculate Cash Outflows: NorthStar totals all expenses and overhead, such as salaries, rent, and inventory.
Understanding Your Cash Flow Statement
A cash flow statement is a financial report that summarizes your cash inflows and outflows over a specific period. It’s divided into three sections:
- Operating Activities: Cash flow from your core business operations.
- Investing Activities: Cash flow from the purchase and sale of long-term assets, such as property and equipment.
- Financing Activities: Cash flow from debt, equity, and dividends.
Tips for Improving Cash Flow
- Invoice Promptly: Send invoices as soon as services are rendered or products are delivered.
- Offer Discounts for Early Payment: Incentivize customers to pay their invoices quickly.
- Negotiate Payment Terms with Vendors: Extend payment deadlines to improve your cash position.
- Monitor Your Inventory: Avoid overstocking to minimize cash tied up in inventory.
- Create a Cash Flow Forecast: Project your future cash inflows and outflows to anticipate potential shortfalls.
“Improving cash flow is often about making small, strategic changes,” says Heather Kirstein, Co-Owner of NorthStar Bookkeeping. “By implementing best practices and monitoring your finances closely, you can ensure your business has the cash it needs to thrive.”
Formulas for Calculating Cash Flow
Here are a few formulas to determine cash flow that NorthStar Bookkeeping employs in documenting your financial resources.
1. Operating Cash Flow
Formula:
Net Income + Depreciation & Amortization – Changes in Working Capital = Operating Cash Flow
Explanation:
This formula calculates the cash flow generated from your core business operations. It starts with your net income and adjusts for non-cash expenses and changes in your working capital.
2. Free Cash Flow
Formula:
Operating Cash Flow – Capital Expenditures = Free Cash Flow
Explanation:
This formula calculates the cash flow available for discretionary purposes, such as dividends, debt repayment, or reinvestment in the business. It subtracts capital expenditures from your operating cash flow.
3. Cash Flow from Investing Activities
Formula:
Cash Inflows from Investing Activities – Cash Outflows from Investing Activities = Cash Flow from Investing Activities
Explanation:
This formula calculates the cash flow generated from your investments in long-term assets. It includes cash inflows from asset sales and cash outflows from the purchase of assets.
4. Cash Flow from Financing Activities
Formula:
Cash Inflows from Financing Activities – Cash Outflows from Financing Activities = Cash Flow from Financing Activities
Explanation:
This formula calculates the cash flow generated from your financing activities. It includes cash inflows from issuing debt or equity and cash outflows from debt repayment or dividend payments.
5. Net Cash Flow
Formula:
Cash Flow from Operating Activities + Cash Flow from Investing Activities + Cash Flow from Financing Activities = Net Cash Flow
Explanation:
This formula calculates your overall net cash flow, which is the sum of your cash flows from operating, investing, and financing activities.
By understanding these formulas and tracking your cash flow regularly, you can gain valuable insights into your business’s financial health.
How NorthStar Bookkeeping Can Help
NorthStar Bookkeeping serves businesses in Orange County, CA, and across the United States. We specialize in QuickBooks cloud integration for on-demand cloud financial reporting and analysis. Our team of expert bookkeepers can help you:
- Track and manage your cash flow.
- Create accurate and timely cash flow statements.
- Develop strategies to improve your cash position.
- Gain a deeper understanding of your business’s financial health.
Contact us to talk about outsourcing bookkeeping for your business.