Anyone who owns a business must’ve heard and known the term cash flow. The understanding of cash flow plays a significant part in the continuity of a business unit.
Business owners may also hear “negative cash flow” when the business is not doing well. This phrase indicates a company’s cash flow health level.
What is cash flow, and what is its importance for business? How to manage a healthy cash flow to sustain a business? Read along to find out!
What is Cash Flow?
Many thoughts cash flow is a business’s income. But this is not true. Cash flow is more than just a company’s income; but the flow of cash entering and leaving a company.
The increase and decrease of cash entering and leaving a company is what we call cash flow. In the business sector, the term cash flow depicts the cash a company made and spent in a certain period or one accounting period.
If the amount of cash entering the company exceeds the amount left, the company has a positive cash flow. Vice versa, if the amount of money left is larger, the company has a negative cash flow.
A healthy cash flow can be determined when a business owner doesn’t have to worry about paying bills and other operational costs.
To make sure that the cash flow is always well monitored, a company should take note of every cash transaction occurring or the equivalent. By recording every transaction, we can track the business’s fund status and the cash balance account in one accounting period.
Thus, we can conclude that cash flow is the movement of cash entering and leaving a company in an accounting period.
Types of Cash Flow
There are types of cash flow generated through business operations, investments, and funding. The cash flow’s function is to determine a company’s cash position and the availability of business cash.
Here are further explanations to better understand the types of cash flow.
Operating Cash Flow
Operating cash flow measures the cash generated and spent in a company’s regular business operations, such as product sales, electricity bills, and employee salaries.
Business operational activities also include all activities carried out to generate income. This includes but is not limited to Providing services to a customer, producing and selling products, paying the bills, and getting more funding.
Operating cash flow is usually written at the beginning of a cash flow report. This number shows the company’s expenses and operational costs, so the business owner may understand what aspects need improvements, such as cutting operating costs or optimizing a specific unit production.
Operating cash flow also shows the company’s current available cash to help the company’s development and growth, also the potential for new business creation.
How can we calculate a company’s operational cash flow? Well, here’s the formula:
Operating cash flow = net income + depreciation – taxes + the changes in working capital
For instance, in November 2022, a company generated Rp40.000.000 income through product sales
Rp5.000.000 of that income is in credit.
The rental tax amount to Rp3.000.000, and the employee salary is Rp8.000.000.
Calculating from those numbers, the company’s operational cash flow in November 2022 is:
(Rp40.000.000 + Rp5.000.000) – (Rp3.000.000 + Rp8.000.000) = Rp34.000.000
Investing Cash Flow
The second type is cash flow from investing activities, which shows the amount of cash a company spent or earned through investing activities in one accounting period.
Investing activities may include asset purchases, such as working tools, properties, and factories (fixed and long-term assets).
On top of that, investing cash flow also include a company’s merger and acquisition of other companies and securities investment such as stocks and bonds.
Here’s the formula to calculate investing cash flow:
Investing cash flow = cash acquired through assets sales and loans – money spent to purchase assets and loans.
For instance, a company earned Rp40.000.000 in cash through stock sales and Rp50.000.000 through bond sales.
But at the same time, the company also spent Rp60.000.000 for investing activities. Therefore, the company’s investing cash flow number is as below:
(Rp40.000.000 + Rp50.000.000) – Rp60.000.000 = Rp30.000.000
Financing Cash Flow
Lastly, we have financing cash flow, which translates to the net amount of funding a company generated in a certain period.
Cash flow from financing activities includes long-term loans, equity, and business dividend.
To calculate financing cash flow, this formula below applies:
Financing Cash Flow = Cash inflow through equity – (dividend paid + repurchasing of equity)
Here’s a simulation to better understand financing cash flow calculation:
A company earns Rp50.000.000 in funding from investors and Rp80.000.000 in company stock sales.
But at the same time, the company must spend Rp40.000.000 to pay off its bank loans.
Therefore, the company’s financing cash flow is as below:
(Rp50.000.000 + Rp80.000.000) – Rp40.000.000 = Rp90.000.000
Ways to Calculate Business Cash Flow
Cash flow is calculated by summing up the operating, financing, and investing cash flow numbers and adding or subtracting it from the net income.
If the cash flow calculation results in negative numbers, use the negative or subtraction formula to calculate the current cash flow balance.
Vice versa, if the cash flow calculation results in positive numbers, use the positive formula.
Here’s the formula to calculate the total business cash flow:
Net income +/- Operating Cash Flow +/- Investing Cash Flow +/- Financing Cash Flow + Initial Cash Flow = The Total Business Cash Flow
Let’s illustrate with the numbers above and calculate the company’s total cash flow.
In November 2022, the company earned Rp20.000.000 in net income, and its initial cash flow number is Rp5.000.000
The previous calculation shows that the company’s operating cash flow is Rp17.000.000, investing cash flow is Rp40.000.000, and financing cash flow is Rp60.000.000.
We can calculate the total cash flow in November 2022 using the positive cash flow formula.
Rp20.000.000 (net income) + Rp 17.000.000 (operating cash flow) + Rp40.000.000 (investing cash flow) + Rp60.000.000 (financing cash flow) + Rp5.000.000 (initial cash flow) = Rp142.000.000
Therefore, the company’s total or net cash flow in November 2022 is Rp142.000.000.
How To Manage Business Cash Flow
Net cash flow doesn’t always have positive numbers. Some tricks can be done to maintain the stability of a company’s cash flow. Here are the tricks to create a positive and healthy cash flow.
- Recording Budgets
To maintain a positive cash flow, every company must first prepare a monthly budget prediction and recording system. Monthly expenses may include supply costs, transportation, monthly installment, etc.
This budget prediction may function as the tool to plan and document all upcoming expenditures.
- Creating Financial Reports
Financial reports are the key to a healthy cash flow. Business owners should always create a financial report to track all monthly cash flows. This way, business owners can easily find out their company’s current cash balance and the cash flow health level.
That’s the definition, functions, and ways to calculate business cash flow. Always conduct a financial evaluation to control the company’s cash flow. Hopefully, this may help to maintain a positive cash flow.
