As a business owner, one of the keys to success is understanding how money leaves and enters your business: your cash flow. Why?
Because knowing how cash flow works helps you determine how your business is doing financially. That way you can make tweaks to your strategy, if necessary, to make and save more money.
You also need to understand how net cash flow works to see how much money your business brings in.
To help you understand net cash flow, this guide will cover:
- What is net cash flow?
- What is a cash flow statement?
- Why is net cash flow important?
- What’s the difference between net cash flow and net income?
- How do I work out my net cash flow?
- What are the limitations of net cash flow?
- How Countingup can help
What is net cash flow?
While general cash flow measures how much money your business brings in (inflows) and spends (outflows), your net cash flow shows how much money it makes during a specific time.
Net cash flow is the sum of your inflows less your outflows. You want to generate a positive net cash flow, meaning your business makes more than it spends. A negative net cash flow means your company spends more than it creates. Consistently generating negative cash flow means your business could eventually run out of money.
What is a cash flow statement?
Businesses record cash flow and net cash flow in their cash flow statement. Your cash flow statement, along with your income statement and balance sheet, is vital for managing your accounting and making sure you have enough cash to keep operating.
Cash flow statements show you how well your company generates cash to pay its debts and fund its operating expenses, such as bills and supplies. The cash flow statement has been a mandatory part of a company’s financial reports since 1987.
Why is net cash flow important?
Knowing how to work out your net cash flow can help you determine how much cash you have available at a given time. You can also use net cash flow to determine how profitable your business is, aka how good it is at making money.
If your business consistently generates positive cash flow, it demonstrates a good chance of succeeding long term. The higher the net cash flow number is, the more successful your business is. On the flip side, a constant negative cash flow could mean you aren’t selling enough products or services. Alternatively, it could mean you spend more money than you should.
Your net cash flow provides valuable insights into your company’s financial health. This knowledge can help you change your business strategy to help your business perform better. Maybe you need to alter your service offerings or cut back on some expenses.
What’s the difference between net cash flow and net income?
You might think that net cash flow is the same as your net income. While the two are similar, your net income and net cash flow have a few key differences.
Net cash flow tells you how much cash flows in and out of your business in a given time, but net income also includes all your expenses (bills, debts, loans, etc.). Net income subtracts operating and non-operating costs from the final sum.
Operating expenses refer to money you spend running your day-to-day operational activities, such as utility bills, buying supplies, or mileage. Non-operating activities refer to money you spend on things that don’t directly link to your everyday operations like taxes or business loans.
Net income also provides a more accurate look into business profitability, while net cash flow indicates your company’s ability to earn a profit from ordinary business operations.
What is net profit?
Your net profit is the money your business has left after accounting for all your expenses and has to be a positive number. If the number is negative, it’s a net loss, meaning your business lost more than it made during that period.
How do I work out my net cash flow?
Here’s how to work out your net cash flow:
Net cash flow = Net cash flow from operations + Net cash flow from investments + Net cash flow from financing
Or to simplify it further:
Net cash flow = Total cash inflows – Total cash outflows
How do these calculations work in real life?
Imagine your company has a net cash flow from operating activities of £50,000 for a year and £20,000 from financing. Your company also lost money from investments, resulting in -£10,000 net cash flow. What is the net cash flow?
£50,000 + £20,000 – £10,000 = £60,000
This means your business’s net cash flow over the given period is £60,000.
Learning how to calculate net cash flow helps you determine how much cash your business generates and if your flows are positive or negative. You’ll gain valuable insight into your short-term financial viability.
What are the limitations of net cash flow?
Cash flow is an excellent way to measure financial health. However, keep in mind that even if you generate positive cash flow one month, it doesn’t necessarily mean you made a profit. Similarly, getting a negative cash flow doesn’t have to mean your business is failing.
For example, taking out a new business loan might create a positive cash flow for that time period but doesn’t prove the company is successful.
By the same logic, negative cash flow doesn’t have to be bad. If your negative cash flow happened because you spent a large sum of money buying new equipment, it could be good for your business. This equipment should help you make more money later.
It’s also important to consider other aspects when calculating your business’ financial strength. Other financial measurements include changes in your overheads (ongoing expenses) and the level of debt you’ve taken on.
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You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple, and straightforward!
Find out more here.