Cash flow: how to calculate it and why is it key for your business?

The cash flow is an indicator of the performance of your venture. As it sounds: it is key to knowing if your business is generating profits or if adjustments need to be made. Does it seem like a very distant concept? Don’t worry. I kept reading that you will find what it is and how to calculate it with examples.

When you start a venture you may feel like you have to know everything. Design, accounting , supplier management. These tasks can be overwhelming if you tackle them all together. But here we are to give you a hand!

We are going to see a key concept to ensure that your business is on the right track: the cash flow.

From this article, you will take away everything you need to know. What is a cash flow? What types are there? Why is it important to calculate? What elements make it up? How can you make yours? That and more below, keep scrolling !

What is cash flow?

The cash flow is the indicator of the performance of your venture . It is made up of the amount of money in either cash or credit that is flowing in and out of your business.

The cash flow is always calculated considering a certain time that, in general, does not exceed one year.

When a cash flow is positive it means that there is more money coming into your venture than going out. Otherwise, that is, if it is negative, the money that enters your business is less. The latter implies that the income is less than what is necessary to cover the expenses of your venture.

Consider that understanding and managing the flow of funds well is key so that your venture does not generate losses. For example, this will allow you to pay suppliers and face fixed and variable costs.

So, the most important thing about making a cash flow is:

  • Know in advance if you are going to have extra money to invest or schedule the payment of liabilities (for example, payment to suppliers) in advance. The latter can allow you to save some interest.
  • Make the necessary calculations to know the inputs and outputs and, thus, have the money to make the necessary payments. In addition, you can program the entries to estimate and prevent possible inconveniences.
  • Have financial planning. This is requested, for example, when you go to a credit institution to apply for loans for entrepreneurs. In line with this, knowing your flow of funds will help you identify the moment in which you need to access a financing option.
  • Predict in a period the inflow and outflow of funds that your venture will have. It will help you both for planning and control, focusing on how to reduce costs and increase your profitability. Forecasts can even be short term.

What are the elements of a cash flow?

We already saw that the cash flow allows you to measure the money that enters and leaves your venture. In addition, we can divide it into 3 sections: operations, investments and financing. We are going to see this classification in depth shortly, but let’s see what common elements they have.

A first element of the cash flow is made up of cash inflows. This is the money that enters your business, whether it is from sales of your products and services, investments, or loans.

You also have another element: money outflows or outflows. In this case, it is about what was spent on supplies, loans and personnel.

So, you can rely on a formula to know how much cash you are going to have at a time or even how much you had in a certain period of time in the past. There is a simpler cash flow formula, which we will see later. Especially if you do not have, for example, amortizations to add to the calculation.

The one you can use in that case to find out is:

Cash Balance = Beginning Cash Balance + Cash In − Cash Out

Types of Cash Flows

As we said, the cash flow of a company is divided into three categories. These are: flow of operating funds, from financial sources and from investment. Let’s see what each one implies.

Operating Cash Flow

Operating cash flows are made up of the money that circulates between your business and your customers, suppliers, equipment and the State (for example, tax payments).

Within “suppliers” you have to consider all those who supply you with products or services that allow you to function, develop products or processes, etc.

This type of cash flow is important because it allows you to know the self-financing capacity of your business. Because? Because you will know how much money is coming in and going out in operations related to your activity. In this way, you will have an overview to know if it is profitable.

Cash Flow from financial sources

The cash flow from financial sources is made up of the movements of money between your venture and financial creditors. In the case of larger companies, we include here the movements of money between the company and its owners.

In this type, we incorporate financial creditors because the money comes from them as a loan, for which you are going to pay interest.

While from the owners, in the case of large companies, money is received as capital contributions and dividends are paid.

So, we are going to consider in the cash flow from financial sources the money that you spend on, for example, repaying loans and the money you receive from, for example, issuing shares.

Investment funds flow

For the flow of investment funds we are going to take into account the movements of money linked to the acquisition of assets in the long term. What kind of assets? They can be machinery, plants, equipment, etc.

We also include the money you receive or spend in relation to the investment in products from which your venture calculates to have a benefit in the future. An example is financial products.

How to make a cash flow for your business?

We already have all the theory clear. Now it’s time for practice. To calculate the cash flow in your venture you have to follow these 3 steps.

1. Choose the time period over which you want to calculate the cash flow

Cash flow can be calculated for a future period of time (projected cash flow) or over the past. Be that as it may, we also said that the period of time does not exceed one year.

So, the first step is that you select the period of time to calculate. The idea is to make it broad enough that calculating your cash flow makes sense.

You can go doing the calculation periodically to check that the performance of your business is what you projected.

2. Identify all the income and expenses of your business

In this step, a previous task is important: make an adequate record of all the income and expenses of your venture. Only by identifying all the money inputs and outputs of your business will you be able to correctly calculate your cash flow.

So how do you make a cash flow? You have to look only at the income and expenses of the period for which you want to calculate your cash flow. You will have to consider, for example, sales, loans, debt collection. As well as expenses related to the activity that you develop.

3. Organize all the information you obtained to analyze your cash flow

Seeing all the data you collected on income and expenses in a table will help you analyze it.

In addition, it is key that in this step you do the math: add up all the income and expenses. Once you do, you will be able to see, on the one hand, the total money that you received and the amount that you spent, on the other.

The formula you are going to use is:

Cash flow = Net profit + Amortizations + Provisions + Accounts payable − Accounts receivable

Let’s see each of its parts:

  • Net profit: you will get it once you calculate the income minus the expenses.
  • Amortizations: consider that not all companies apply amortizations of investment goods. Depreciation involves an accounting procedure in which the value of an asset, for example property used by a business, is spread over all the years of its useful life. That is, the expense is divided in that period.
  • Provisions: it is an occasional depreciation that will require you to make an extra distribution of funds. For example, that you regularize a tax payment situation.
  • Accounts payable: are the debts that you still have to cover.
  • Accounts receivable: are the income of money that will happen or happened in the time that you chose to calculate the cash flow.

Once you do the calculation, if this is greater than 0 it implies that the cash flow is positive and that your venture is generating. On the other hand, if it is negative, it implies that there are losses.

You will also be able to see this in the accumulated cash balance. For example, by calculating over a period of 4 months, you can add month by month what is left of the balance in the box. This way you will know the total amount of money that you had left in that period of time.

As you can see, the cash flow result is not just a number. It allows you to identify the behavior of money in your business over a period of time to make decisions based on that.

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