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written by | June 27, 2022

How to Calculate Cash Flow? Formulas, Calculations, and Example

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Cash flow statements play a vital role in understanding the liquidity status of an organisation. A cash flow helps investors understand the volume of revenues an organisation has earned over a said period of time. A positive cash flow statement affirms the healthy financial position of an organisation to investors. It serves as a blueprint informing investors about the money being spent, earned, and invested. It reflects the amount of cash owed to creditors and how much and when debts are repaid, all of which detail the organisation's financial standing. These details impact the expansion and growth objectives of every organisation. This helps in futuristic planning, setting new goals, and helps the organisations make strategic decisions in mergers and acquisitions. It also gives an organisation an understanding of the requirement of working capital and the various expenses made by an organisation. Unlike income statements, cash flow statements do not include non-cash expenditures. A cash flow statement clarifies whether an organisation is earning enough and more revenues that help it tide over its expenses.

Did you know? Almost 82% of small commercial enterprises experience losses because of failure to maintain cash flow statements?

Also Read: Fund Flow Statement - Meaning, Format And Examples

Understanding the Calculations of Cash Flow

The primary constituents of a cash flow include three distinct areas. These are listed below:

  • Investment activities
  • Operation activities
  • Finance activities.

The 3 important cash flow formulas include:

  • Free cash flow formula
  • Cash flow forecast
  • Operating cash flow formula

Free cash flow formulaOperating cash flow – Capital expenditure

Another simple way of looking at it = Net operating profit (after taxes) – Net investment in operating capital

Operating cash flow formula: Involves the sum of revenues earned by regular business operations. Formula = Operating income (Y) Depreciation – Taxes change in the working capital

Cash flow forecast = The anticipated amount of cash in receivables -  the volume of cash intended for expenses (for a distinct time frame)

Also Read: Know All About Cost Accounting

Workings of the Free Cash Flow Formulas:

This is one of the most simple calculations to understand how much excess cash your business enterprise has after it completes payments towards purchases of fixed assets as well as its operations. Let us look at a typical example of this formula:

Good Health is a homegrown wellness organisation desirous of expansion and diversification. It is keen on attracting new investments. The company’s income statement indicates a net profit of ₹ 100,000 after payment of taxes in the earlier year. To calculate the free cash flow, you have to add the non-cash expenditures incurred, if any, that lowered the net income. These could be amortisation or even depreciation. You also have to make profit adjustments to establish the changes in the working capital.

Amount of depreciation - ₹10,000

Amount involving amortisation - ₹5,000

Current assets of Good Health - ₹100,000

Current liabilities of Good Health - ₹80,000

Purchases of fixed assets - ₹50,000

Free cash flow formula = ₹100,000 – (₹100,000 - ₹80,000) ₹10,000 + ₹5,000 = ₹95,000

Free cash flow = ₹ 45,000 (₹95,000 - ₹50,000)

A company that reflects excess revenues is not necessarily a positive sign of its overall performance. Such a company may not have upgraded its technology or machinery. In the event of a breakdown, the company will cease functioning, which will impact its sales and revenues. The brand may also get negatively impacted. Similarly, a negative cash flow does not necessarily mean a company is experiencing losses. The company may have decided to invest in the latest technology and upgrade its machinery, which may have involved using the extra cash available on hand.

Operating cash flow, in simple words, signifies the volume of revenue earned by your company from regular business activities. The company does not take recourse to sources of income like interest. The inflow of cash always has to exceed the outflow of cash. This enables the company to earn profits and make timely payments without any hindrances.

Also Read: Accounting Equation: Overview, Formula, and Examples

Operating Cash Flow Formula:

Desi Hats is a company which manufactures headgear unique to every Indian state. It has only one market competitor, namely Phirangi Hats and wants to expand its business beyond boundaries. Its financial statement includes:

Net revenue earned - ₹100,000

Depreciation amount - ₹10,000

Changes in accounts receivables - ₹50,000

Inventory change - ₹20,000

Accounts payable change - ₹25,000

Therefore the operating cash flow :

₹55,000 = ₹100,000 - ₹50,000 + ₹20, 000 - ₹25, 000 + ₹10, 000

Desi Hats has ₹55,000 cash flow from its business operations at the end of the financial year. It can re-invest this to enhance creative and quality products to defeat the one existing competitor.

Cash Flow Forecast:

Every business should monitor its cash flow at regular intervals. This will enable them to understand various issues like the requirement for more cash. It also helps an organisation not experience an unnecessary outflow of cash. It aids in understanding trends and the right timing to make necessary investments in the larger interests of the organisation to function more effectively. In addition to revenue earned from regular operations, cash receivables can also include money that has come from previous invoices whose payments were due. Cash that is spent could be towards payment of income taxes, salaries, wages or even interests.

Formula:

Net cash flow – Total cash received – total cash spent

Once you are familiar with the calculation of cash flow, it becomes very easy to make a projection of cash flow. 

Given below are the steps to create a forecast for cash flow:

  • One of the first steps is to consider a time frame – this could be a quarter of a year, 3 months or even six months
  • Once you have defined a time frame, you should calculate the total value of your anticipated commercial transactions during that time period.
  • Detail the number of cash receivables – you can start with things you are confident about, e.g., recurring invoices.
  • To this above amount, you should add the sum of other cash inflows like sales of assets, tax rebates, if any, likely grants, and investments.
  • Now pin down details of the amount of cash you anticipate spending across the forecasted time frame. This could include rent of the commercial premises, taxes, salaries, computer hardware, and the latest or upgraded computer software.
  • Now you will have to resort to the net cash flow formula. If your cash flow forecast indicates a negative amount, it implies proper measures to be implemented at once in order to eliminate cash outflows. A positive cash flow forecast is always welcome but should not make you complacent. There can be unforeseen contingencies which may arise – like geopolitical issues which may disrupt the economy and the operations of businesses. 

There are various ways in which you can prevent cash outflows and judiciously manage your cash. Some of these include:

  • Monitor all your cash spends and try to curb the unnecessary ones
  • Become a good negotiator for all your business deals
  • Create regular forecasts for sales
  • Incorporate meaningful procedures to monitor and control credit
  • Keep checks on all spending activities and implement controls wherever required
  • Incorporate firm policies on stock control
  • Read financial reports

Also Read: What are Consolidated Financial Statements?

Conclusion:

One of the most common reasons for the failure of small businesses is their inability to maintain requisite cash reserves. Every business needs a constant supply of cash to meet its numerous obligations of payments, investments, as well as growth plans. A dearth of funds disrupts the entire commercial operations leading to unpleasant business conditions. Monitoring your business operations and activities is imperative to all businesses. This article helps you understand the meaning of cash flow, the various methods of calculating it and its relevance to a business enterprise. Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.

FAQs

Q: Explain the cash flow ratio formula?

Ans:

This formula involves dividing the Operating cash flow by the current liabilities of a business.

Q: How to calculate cash flow?

Ans:

You calculate the cash flow by adjusting the net income. You do this by deducting or adding the difference that arises from transactions that do not involve cash.

Q: How do you define the operating cash flow formula?

Ans:

Operating cash flow is the total revenue earned from the regular operations of a business but within a defined time frame. The operating cash flow formula is as follows: Operating income (Y) Depreciation – Taxes change in the working capital. It takes into account the total revenues earned by regular business operations.

Q: What is the free cash flow formula?

Ans:

The free cash flow formula is as follows: Operating cash flow – Capital expenditure. In simple words, it means the amount of cash a business has on hand after meeting all necessary capital as well as operating expenses.

Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.