Cash flow is the movement of money in and out of a business during a specific accounting period. When reviewing your financing statements, you’ll find either a negative or positive cash flow, depending on whether your company spends more than it makes or makes more than it spends.
Your cash flow comes from three activities:
- Operating
- Investing
- Financing
This article discusses the “ins” and “outs” of the types of cash flow and how they might impact your business.
What is cash flow?
Cash flow is the net amount of cash that moves in and out of your business during a given period. This includes all money your company makes and spends.
Your company’s cash flow statement provides a detailed look at how your business’s cash has moved during this period, which could be monthly, quarterly, or annually. Essentially, it shows you where your money came from and where it went, offering an important assessment of your business’s financial health. This assessment is important when budgeting and showing investors.
Your company’s goal should be to generate a positive flow of cash, indicating that you can cover future obligations and expenses because your liquid assets are increasing—in other words, you’re successfully operating and making money.
Of course, not every business will be immediately profitable. Most startups take three to four years to turn a profit. But as you grow and build your company, showing a positive cash flow can help you attract investors if your business wants to expand into new markets, upgrade systems to better reach current markets, and more.
The 3 main types of cash flow
Below, we break down each type of cash flow and give the formula for each source. We also share some common items that fall under each type of cash flow.
If this seems intimidating, don’t worry. You can always hire a financial analyst to review your company’s cash flow. Upwork can connect you with independent experts to help you understand your company’s financial health.
But if you want to know more about tracking and measuring your cash flow, you can follow these jump links:
- Cash flow from operations
- Cash flow from investing
- Cash flow from financing
Cash flow from operations (CFO)
Your operating cash flow measures the cash generated or consumed by your company’s standard operating activities—in other words, sales, bills, and wages. These business activities can include generating revenue by providing services to your customers or producing and selling goods, paying expenses, or funding working capital.
The cash flow from operating activities is found in the first section of your cash flow statement. This number is integral to your business’s financial health. It shows where and how money is being spent and offers insight into your company’s operations and where you make improvements. It also shows how much cash your company has available to finance your business’s growth and new endeavors.
You can calculate your company’s operating income cash flow in two ways: the indirect method and the direct method.
With the indirect method, you’ll add your business’s net income, your non-cash expenses, and changes in your working capital using the following formula:
Operating Cash Flow = Net Income + Non-Cash Expenses + Changes in Working Capital
The direct method tracks all of your business’ cash transactions during a specific period. It uses your company’s actual cash receipts to determine your operating cash flow.
Unlike accrual accounting, which recognizes earned revenue, the direct method instead focuses on payments received from customers and money paid to suppliers. While it provides greater detail about your operating cash flow, it tends to be more time-consuming and difficult.
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Items to include
The following items would fall under your business operations cash flow:
- Cash received from sales of goods: The money you make from products your company manufactures and sells is considered a cash inflow and is a big part of your operational cash flow.
- Purchase of day-to-day supplies: Money spent on daily supplies for your company to do business is subtracted from any sales made as a cash outflow.
- Purchase of inventory: The cost of inventory purchased—either merchandise through a third party that you resell or the supplies needed to manufacture your goods—is also subtracted from your operational cash flow total as a cash outflow.
- Utility bills: The cost of utility bills is another type of cash outflow included in your operational cash flow.
- Employees’ wages: Salaries and wages spent during a specific accounting period are also considered cash outflow.
Cash flow from investing (CFI)
This section of your cash flow statement shows how much money your company has spent or made through investment activities during specific accounting periods. These activities can include purchasing assets—such as equipment, property, factories (which are, essentially, fixed assets and long-term assets)—mergers with and acquisitions of other companies, and investments in marketable securities like stocks and bonds.
The formula
To calculate your cash flow from investing activities, you’ll subtract the money your business has spent on buying assets or on loans from the money your company has received from the sale of assets and any amounts collected on loans.
Investing cash flow = Money received from the sale of assets and any amounts collected on loans – the money spent to buy assets and/or loans
Items to include
While we’ve already talked a bit about some investing activities that might be included in this section of your cash flow statement, let’s take a closer look at some of them:
- Purchase of investments in the market: If your company makes any investments in marketable securities, such as stocks and bonds, it’s considered a cash outflow.
- Acquisition of a business: This includes any payments related to merging with or purchasing another company.
- Loans: The collection of advanced loans or debt repayment is considered an investing activity on your cash flow statement.
- Purchase of a fixed asset: Also called capital expenditures or cash equivalent, this cash outflow includes the purchase of any property, plant, or equipment your company makes (and the sale of these items would be a cash inflow).
These assets depreciate over time, reducing the amount of taxes you’ll pay. For many companies, positive cash flow from operations is used to offset the negative cash flow from investing. And profitability comes as investments are paid down.
Cash flow from financing (CFF)
The final section of your cash flow statement is the net amount of funding your company generates over a specific period. Essentially, your cash flow from financing activities boils down to how your company’s cash moves among its owners, investors, and creditors. This section includes your business’s long-term debts, equity, and dividends.
The formula
To calculate your financing activities’ cash flow, use the following formula:
Cash flow from financing = Cash gained by equity – (Dividend payments + Repurchase of equity)
Items to include
The three variables used to calculate your financing cash flow are:
- Cash gained by equity: This cash inflow from external lenders can refer to both short-term and long-term borrowings. These lenders become partial owners in exchange for providing financing.
- Dividend payments: This cash outflow pays dividends to everyone who has invested in your company. These could be recurring or one-time cash payments.
- Repurchase of equity: Another cash outflow, refers to the repurchase of shares in your company that was previously issued and traded. This reduces the number of shares in circulation, thus reducing your company’s net dilution (i.e., the reduction of existing stockholders’ ownership percentage in a company due to the issuance of additional stocks).
What about free cash flow?
Your company’s free cash flow is the total cash that remains after your business pays its operating expenses and any anticipated capital expenditures—meaning any physical assets you’re planning to purchase, like property and equipment.
Free cash flow isn’t considered the same type of cash flow as operating, investing, or financing. It’s more of a measure of performance and indicates how well your company is doing.
Free cash flow measures change to your working capital and are especially important to investors. It shows them the health of your company (both your assets and liabilities), trends in your business, and the cash liquidity that you have available to invest.
In short, it helps them evaluate whether they want to invest in your company by showing them your business’s ability to survive and grow.
If you have experience with free cash flow and think you can help someone out, consider freelancing through Upwork. We can connect you to the best cash flow modeling jobs.
Categorize your cash flow the right way
Generating accurate and comprehensive cash flow statements for each accounting period is integral to the success of your business. Without this information at your fingertips, you’ll lack valuable data about how your different cash flows are affecting your profitability and how attractive your business might be to investors.
Preparing these important documents can be both overwhelming and intimidating even for seasoned entrepreneurs. If you lack the time, wherewithal, or in-house talent to create your cash flow statements, Upwork can help you reach a pool of independent financial analysts. These independent workers can help you produce and evaluate a statement of cash flows, balance sheets, income statements, and other important financial statements and documents.
Our network of professionals can help you better assess your company’s financial health and take your business to the next level.
