As an entrepreneur, you focus on the growth of your business and making profitable choices. Making investments is inextricably linked to this. It’s not just about whether the investments yield something, but also whether they fit within the budget. It is important to be constantly aware of your company’s cash flow. What to watch out for and how to calculate cash flow, you can read more about in this blog.
What is cash flow?
A company’s cash flow is determined by the amount of money coming in and going out over a certain period. It is the difference between income and expenses. These incomes and expenses are not lumped together but divided into the following three categories:
- Operational cash flow: all income and expenses related to the daily operational activities within the company. This includes the purchase of goods, salaries, and costs for selling services and products.
- Investment cash flow: all income and expenses related to investments in the company. Think of costs for computers, furniture, and machines, but also income from, for example, selling used computers. These activities are called investment activities.
- Financing cash flow: all financing activities that bring income and expenses, such as loans and shares.
Difference between cash flow & profit
The turnover, the profit you make, and the cash flow of your company are three different things. Therefore, it is good to highlight the differences. Firstly, the turnover is calculated by multiplying the rate of your product or service by the sales, so the number you have sold. The costs you incur for materials, marketing, and the like are then deducted from the turnover to leave the profit at the bottom line. This amount is not the same as the cash flow. The profit you have made may still only be on paper, while in reality, you still have to receive payments from customers. The cash flow is the amount that is actually in the account at the end of a specific period, even if there are still outstanding invoices.
The importance of cash flow for business operations
Cash flow is an important factor in business operations because cash flow affects a company’s financial stability and growth opportunities. A positive cash flow means more money is coming in than going out, indicating financial stability. Conversely, a negative cash flow indicates financial problems and a lack of liquidity.
Moreover, assessing cash flow helps identify inefficiencies in the business process. For example, analyzing cash flow can reveal delays in collecting receivables or paying creditors. If there is too long a time between delivering a product or service and payment, this indicates inefficiencies in accounts receivable management or problems with payment terms with suppliers.
How can you calculate cash flow?
Do you want to calculate the cash flow for your company? For this, you can consult the following formulas that specifically relate to the aforementioned categories. To calculate cash flow correctly, you need to have a complete overview of the income and expenses within a defined period. Make sure you have all the data visible and categorized correctly.
Calculating operational cash flow
Operational cash flow provides insight into your company’s liquidity. This allows you to assess the company’s performance to make informed decisions about financial strategy and possible future investments. To calculate operational cash flow, you need the following data:
- Net profit: net profit is calculated by reducing gross profit by operating expenses. Depreciation of the value of the assets. Think of buildings, machines, and equipment and select the period in which they are used.
- Changes in the company’s working capital: these consist of current assets (such as inventory) and short-term liabilities (such as loans).
Enter the data into one of the formulas below to calculate operational cash flow:
- net profit + depreciation = operational cash flow
- net profit – change in working capital = operational cash flow
Calculating investment cash flow
Investments you have made in the relevant period fall under investment activities and should therefore be included in the investment cash flow. This also applies to income you have generated by selling goods. Insight into this helps you assess the company’s performance. Moreover, you can make better decisions about possible new business-related investments. If you want to calculate the investment cash flow over a certain period, consult the data below:
- Expenditures on investments: these are the expenses from the purchase of assets, such as equipment and real estate.
- Income from divestments resulting from the sale of assets, for example, machines or real estate.
Enter the data into the following formula:
Income from divestments – expenditures on investments = investment cash flow
Calculating financing cash flow
Loans, shares, and such financial data determine the financing cash flow. When your company receives more money from financing sources than it spends, that is a good sign for your company’s financial health. Conversely, your company may run into financial problems. Therefore, it is essential to continuously monitor and improve the financing cash flow where necessary. With the data below, you can calculate the cash flow:
- Increase or decrease in equity, which consists of the value of shares and other assets. Equity is total assets minus total liabilities (debts such as loans, taxes, and outstanding bills).
- Increase or decrease in long-term debt. The company’s long-term debt consists of loans, credits, and other financial obligations.
Enter the data into the formula below to arrive at the financing cash flow:
Increase or decrease in equity – increase or decrease in long-term debt = financing cash flow
Important points to consider when calculating cash flow
If you want to calculate the cash flow for your company, it is not only essential to have the data complete and to enter the above formulas accurately. Also, avoid the following common mistakes:
- Forgetting important income or expense items: you must include all income and expense items in the calculation. If you overlook one item, it can give a distorted picture of the cash flow.
- Incorrect allocation of data: we have mentioned different types of cash flow including associated formulas. These three categories are there for a reason, so it is important to categorize income and expenses correctly. Incorrect allocation leads to an inaccurate cash flow calculation.
- No delineation in time periods: when you want to calculate cash flow, it is essential to delineate specific time periods within which the income and expenses have occurred. Think of a period of a month, quarter, or year in which you get a realistic picture of the cash flow.
- Forgetting non-cash flows such as depreciation and value changes that impact cash flow. Depreciation is not direct expenses. If you do not include these in the calculations, you get an incorrect picture of the available resources needed for payment obligations. For value changes, think of the revaluation of assets. If the value of assets you want to sell increases, your company may generate extra money. Forgetting such potential cash flows results in an incomplete picture of available resources.
How Payt helps you calculate cash flow
Do you want help calculating and improving your company’s cash flow? A first step is to automate accounts receivable management. Our credit control software can do this for you. Additionally, the software helps you improve financial control over the company, saving you valuable time. Fill in the form below to request a live demonstration. You can try our software without obligation so that you have the opportunity to directly experience the benefits of our credit control system and quickly gain insight into the possibilities.