Important cash flow formulas
Free Cash Flow = Net income +
Depreciation/Amortization – Change in Working Capital –
Capital Expenditure
Operating Cash Flow = Operating Income + Depreciation
– Taxes + Change in Working Capital
Cash Flow Forecast = Beginning Cash + Projected
Inflows – Projected Outflows = Ending Cash
The three cash flow formulas above each have their own
benefits and tell you different things about your business
Cash flow problems are never fun (remember they’re
responsible for a large majority of small business failures), so
it’s important to ensure positive cash flow before you start
spending.
1. Free cash flow formula
Free Cash Flow = Net income +
Depreciation/Amortization – Change in Working Capital –
Capital Expenditure
One of the most common and important cash flow formulas is
free cash flow (or FCF).
It helps the business owner to know the cash available,
or free to use. Such as:
Can you afford to invest in that new software
Do you have enough cash on hand to pay for that virtual
assistant when their invoice comes due?
How much cash do you have free to spend on thank you cards
for your clients?
How to calculate free cash flow
company Income Statement or
Balance Sheet to pull key financial numbers.
a balance sheet, showing assets and liabilities.
Net income: The total income left over after you’ve deduced
your business expenses from total revenue or sales. You’ll find
this on your Income Statement.
Depreciation/Amortization: Many of your business assets
(like equipment) lose value over time. Depreciation is the
measurement of how that value decreases.
Amortization, on the other hand, is a method of breaking
down the initial cost of an asset over its lifetime. You’ll find
depreciation and amortization on your Income Statement.
Working Capital: Working capital is the difference between
your assets and liabilities and represents the capital used in
the day-to-day operation of your business. You can calculate
your working capital using the total assets and liabilities on
your Balance Sheet.
Capital Expenditure: Capital expenditures include money
your business spends on fixed assets, like land, real estate, or
equipment. You can find your capital expenditure on the
Statement of Cash Flows.
With that knowledge in hand, the basic formula for free cash
flow looks like this:
Free Cash Flow
Randi’s a freelance graphic designer—she needs to calculate
her free cash flow to see if hiring a virtual assistant for 10
hours a month is financially feasible.
Her financials for the year look like this:
Net income = $80,000
Depreciation/Amortization = $0
Change in Working Capital = – $10,000
Capital Expenditure = $2,500 (Randi bought a new iMac last
year)
Randi’s free cash flow is represented by: [$80,000] + [$0] – [-
$10,000] – [$2,500] = $67,500
This implies that she has $67,500 in available cash to reinvest
back into her business.
2. Operating cash flow formula
cash flow from operations helps in getting an accurate
overview of your cash flow.
While free cash flow gives you a good idea of the cash
available to reinvest in the business, it doesn’t always
show the most accurate picture of your normal, everyday
cash flow.
That’s because the FCF formula doesn’t account for
irregular spending, earning, or investments. If you sell off
a large asset, your free cash flow would go way up—but
that doesn’t reflect typical cash flow for your business.
When you need a better idea of typical cash flow for your
business, you want to use the operating cash flow (OCF)
formula.
When intending to secure outside funding from a bank or
venture capital firm, they’re more likely to be interested
in your operating cash flow.
to calculate operating cash flow:
Just as with our free cash flow calculation above, you’ll want to
have your Balance Sheet and Income Statement at the ready,
so you can pull the numbers involved in the operating cash
flow formula.
There’s one other financial metric you’ll need to know for this
calculation:
Operating Income: Also called Earnings Before Interest and
Taxes (or EBIT) and profit, your operating income subtracts
operating expenses (like wages paid and cost of goods sold)
from total revenue. You can find operating income on your
Income Statement.
The basic OCF formula is:
Operating Cash Flow = Operating Income + Depreciation
– Taxes + Change in Working Capital
A chart showing indirect method and direct method. Under the
indirect method, there is Net Income; Adjustments
(Depreciation and amortization, Changes in working capital);
Net cash from owner; and Activities. Under direct method,
there is collections from customers; deductions (payments to
suppliers, wages); net cash from operating; and activities.
Operating Cash Flow Example
Say Randi, our favorite freelance graphic designer has the
following financial transactions for the year
Operating Income = $85,000
Depreciation = $0
Taxes = $9,000
Change in Working Capital = – $10,000
Randi’s operating cash flow formula is represented by:
[$85,000] + [$0] – [$9,000] + [-$10,000] = $66,000
That means, in a typical year, Randi generates $66,000 in
positive cash flow from her typical operating activities.
3. Cash flow forecast formula
FCF and OCF give you a good idea of cash flow in a given
period, that isn’t always what you need when it comes to
planning for the future.
That’s why forecasting your cash flow for the upcoming
month or quarter is a good exercise to help you better
understand how much cash you’ll have on hand in the
future.
How to calculate your cash flow forecast:
Your cash flow forecast is actually one of the easiest formulas
to calculate. There aren’t any complex financial terms involved
—it’s just a simple calculation of the cash you expect to bring
in and spend over (typically) the next 30 or 90 days.
Cash Flow Forecast = Beginning Cash + Projected
Inflows – Projected Outflows = Ending Cash
Beginning cash -this is how much cash your business
has on hand today—and you can pull that number right
off your Statement of Cash Flows.
hProject inflows are the cash you expect to receive during
the given time period. That includes current invoices that
will come due and future invoices you expect to send and
receive payment for.
Project outflows are the expenses and other payments
you’ll make in the given timeframe.
Example of Cash Flow Forecast
Randi example, let’s say she has:
Beginning cash = $30,000
Projected inflows for the next 90 days = $30,000
Project outflows for the next 90 days = $4,000
Here’s what her cash flow forecast looks like:
[$30,000] + [$30,000] – [$4,000] = $56,000
That means Randi’s forecasted cash flow for the upcoming
quarter is $56,000
Operating Cash Flow = Operating Income + Depreciation –
Taxes + Change in Working Capital
Cash Flow Forecast =: Beginning Cash Flow + Projected
Inflow – Projected Outflow
Determine the Free Cash Flow for an Estate Agent Company
whose financial outlook for the year is as presented below:
Net Income = N 2,850,000
Depreciation = N 400,000
Taxes = N 290,000
Change in Working Capital = N 300,000
Determine the Cash Flow Forecast for the year 2024 of a real
estate investment company outfit if the financial outlook for
the year 2024 is as follows:
Beginning cash for year 2024 = N 13,800,000
Projected Inflow from January to June = N
17,000,000
Projected Inflow from July to December= N
14,000,000
Projected outflow from January to December = N
16,000,000
Determine the Operating Cash Flow for a Mortgage Company
whose financial outlook for the year 2023 looks like this:
Operating Income = N 11,850,000
Depreciation = N 1,200,000
Taxes = N 290,000
Change in Working Capital = N 750,000
