Data Science



A Beginner’s Guide to Cash Flow

Do you have trouble keeping a track of your expenses? Do you often find yourself overwhelmed with a huge pile of unpaid bills every so often? If so, chances are you aren’t really all that familiar with cash flow. The good thing is, we’ve got everything you need to know about cash flows right here.

Before we get down to the finer details let’s first establish what cash flow is. Cash flow is basically the money flowing in and going out of your business. When there is more money flowing into your business, you have a positive cash flow with which you can pay your bills and keep your business running. 

On the other hand, when there is more money going out of your business you have a negative cash flow.

For your business to stay afloat, you need cash to cover your expenses. You need to understand cash flow to balance inflows and outflows in a way that keeps operations moving forward. 

Having a better understanding of cash flow not only helps make strategic business decisions but also gives you the foresight to map out the future of your business.

What makes up cash flow?

Cash flow shouldn’t be confused with profit or revenue. Cash flow measures all inflows and outflows of money in your business whereas revenue and profits both only consider the money you make, and expenses from business operations. 

It is common for businesses to have a positive cash flow and still be considered profitable due to inflows from sources that aren’t included in operations.

Apart from normal business operations that influence revenue and profits, cash flows also include the flow of money from financing, and investing activities.

How do you calculate cash flow?

The first step to calculating cash flow usually requires you to prepare a cash flow statement. Sure, an income statement can give you figures on revenue and profit; and a balance sheet can even show you how much cash you have. 

But only a cash flow statement can tell you exactly how, when, and where cash is flowing into or out of your business in a certain period.

You can create a cash flow statement for whatever time frame suits your needs, but most businesses tend to maintain monthly cash flow statements.

The simple net cash flow formula is:

Net cash flow = net cash inflows – net cash outflows

As touched upon earlier, the 3 areas that influence cash flow are:

  • Operating activities – these activities include the money flowing in and out of your business involving normal business operations such as: money received from sales, and money paid for rent
  • Financing activities – money flowing between your business and its owners and creditors such as: money received from a bank loan, and repayment of lease obligations
  • Investing activities – it refers to how much money has been used in, or generated from investing such as: money received from sale of property, and money paid to purchase equipment

You can calculate cash flows in one of the two following ways: 

  1. Direct method – this method lists all of your cash income and payments separately. Its detailed and specific nature make it very time-consuming to prepare. Unless you’re a large organisation that not only has the resources to, but absolutely needs to keep a track of many activities, this method probably isn’t for you.
  2. Indirect method – All you have to do is adjust your net income based on cash inflows and outflows to figure out how much money you have in hand. As the simpler of the two methods, this is the most widely a used method of calculating cash flow

Cash flow statement formula = Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure

Frequently Asked Questions (FAQs) about cash flow

1. What are some good habits to maintain healthy cash flow?

  • Make sure your business is profitable, always try to ensure you sell more than you spend as a rule of thumb
  • Make use of negotiations to get good profitable deals
  • Save money wherever you can and build up reserves to make sure you don’t run out of money at the first sign of a crisis
  • Liquidate obsolete assets

2. What happens when cash flow is negative?

A negative cash flow is usually down to poorly managed receivables and a misunderstanding of how to use credit. Having negative cash flow temporarily is normal but if you can’t turn it into positive cash flow, your business is bound to fail. Businesses can’t pay their bills with a negative cash flow, and are often forced to borrow money which could lead to an endless cycle of debt.

3.What is Free Cash Flow (FCF)? How do you calculate Free Cash Flow?

Free cash flow is the amount of cash a business generates after taking into account working capital expenditures and expenditures on fixed assets. To calculate Free cash flow, you need to add depreciation & amortisation to your earnings before-tax and interest, and then subtract changes in capital expenditures and working capital

4. How do I calculate operating cash flow?

You can calculate operating cash flow by adding non-cash expenses, and changes in working capital to your net income.

Operating cash flow = Operating income + depreciation – taxes + changes in working capital

Analysing your operating cash flow gives you a view of the individual parts of your business.

5. What is the difference between cash flow and net income?

Cash flow is determined by the change in cash balance from one accounting period to the next as a result of inflows and outflows in the given period. Whereas net income is the gross income minus expenses in an accounting period.

 6) How can I increase my cash flow?

  • Encouraging customers to pay on time with early-payment discounts, and customer service efforts can help your business get their receivables faster
  • A business accountant can also help you cut corners and assess which areas you can increase your cash flow from
  • Look for ways to increase your revenue – sell more products, raise prices, take on more orders, etc.
  • Strategically align your invoices that merges your payables and receivables in a positive cash flow manner to manage money coming in and going out.
  • You might also want to consider Hero Vired’s Certificate Program in Financial Analysis, Valuation & Risk Management that covers ‘cash flow analysis’ that can deepen your understanding and in-turn help increase your cashflow.

  7) What are some of the early signs of cash flow problems?

  • You have a lot of short-term debt
  • You are too reliant on big customers that pay large bills when you’re in a pinch
  • You have an access of inventory with low sales
  • You have trouble getting steady payments and are handling too many receivables
  • You don’t get discounts while paying your bills

           If you catch these problems early on, you can analyse your cash flow and work on improving it. 

1.How many businesses fail due to cash flow problems?

About 82% of small businesses fail due to cash flow issues and poorly managed finances with    continued negative cash flows forcing them to shut down.

2. What is after-tax cash flow?

Cash flow after tax (CFAT) is calculated by adding non-cash expenses like restructuring costs, and depreciation back into net income. It shows a business’ ability to generate cash flow from its operations.

 10) How do I perform a cash flow forecast?

For your business to succeed in the long run, you need to be able to leverage you’re the information at your disposal to predict your future financial needs. Here’s how you forecast your cash flow: 

  1. i) Calculate assumptions – Based on past information and anticipated future business, you need to predict and make assumptions regarding price increases, sales estimates, sales cycles, and general cost fluctuations, among other things.
  2. ii) Anticipated sales for the next period – Grouping the previous year’s sales with expected trends should give you a good idea of what to expect, and anticipate your expected sales.

iii) Expected additional cash – Your additional income will also be key to accurately determining your forecast. This should include include investment money, tax refunds, grants etc.

  1. iv) List down expected expenses – These will include capital investments, cost of operations, employee payroll, etc. An accurate estimate of your spending over the coming period will help you plan enough reserves for cash flow.
  2. v) Analyse the information – As a continually changing part of your business, understanding where, when, and how the cash flows in and out of your business will help you make correct strategic decisions and ensure a positive flow of cash.

    11)   How do I know if my cash flow statement is correct?

All you have to do is analyse and verify the information and amounts thoroughly. Verify every detail and trace its steps to ensure there are no gaps in the cash flow statement.

    12)   Can cash flow be sheltered by depreciation?

Since depreciation is spread over a period of years it doesn’t have an immediate effect on cash flow but if it can absorb some of your taxable income it can have a positive impact on cash flow on paper.

What is cash flow analysis?

Preparing a cash flow statement is just the first step of managing your cash flow. It’s everything that comes after this that can help make a difference to your business. Cash flow management requires you to track your cash flow, and analyse the numbers to figure out where you can make changes in your business to increase your cash flow.

A cash flow statement analysis requires you to use the information to make strategic business decisions that moves the cash flow of your business in a positive direction. Making these decision is part of cash flow management. 

The Hero Vired Certificate Program in Financial Analysis, Valuation & Risk Management cover topics like ‘Free Cash Flow Analysis’, as well as industry topics such as ‘Corporate Finance & Financial Markets, and Risk & Return’. 

We provide our participants with comprehensive instructions and training required to compete successfully in swiftly developing financial markets. The program teaches you how to evaluate the financial consequences of business decisions and accurately study and forecast cash flows.

The theoretical & real-world concepts of finance will develop you into an industry-ready professional who is eligible for Columbia University’s (Columbia X) Professional Certificate, with skills that you can successfully apply to advance your career.

Cash flow is the end all be all to for a business. Going into business blind and completely neglecting cash flow is a recipe for disaster. Unfortunately, this is something many businesses don’t quite understand until it’s too late. Neglecting cash flow is a major reason for many a business to not be able to reach their full potential.

Understanding how it impacts the business, how to calculate it using a cash flow statement, and how to improve it, may seem like a lot of work initially. But if you take the time to diligently monitor your cash flow, it will be worth its weight in gold. 

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