Learn About Net Cash Flow and How It Is Used
If you are running a business, it's essential that you understand cash flows to ensure your company is profitable and has enough capital on hand. Your net cash flow can change from month to month, so it's important to calculate it regularly to have an accurate picture of your business' success. Net cash flow is the difference between a company's cash payments and cash receipts. It's generally calculated on a monthly basis, and you'll find it on the company's cash flow statement.
If a company has a strong and positive net cash flow month after month, it's considered to be financially strong, at least in the short term. If, on the other hand, it has weak cash flow or even negative cash flow (it's losing money), then it's financially weak and may even be in danger of bankruptcy. Net cash flow provides the funds a company needs to expand, to invest in research or in new equipment, or to pay dividends or reduce debt.
How to Calculate Net Cash Flow
Although you can find net cash flow on companies' cash flow statements, calculating net cash flow is simple. You just need to know how much a company brought in and how much it paid out over any given period. Here's the formula:
Net Cash Flow = Cash Receipts - Cash Payments (during a period of time)
Another way to look at net cash flow is to consider the Statement of Cash Flows and its three different parts, which include: Cash Flows from Operating Activities, Cash Flows from Investing Activities, and Cash Flows from Financing Activities.
When you develop the Statement of Cash Flows, the total is the Net Cash Flows for the firm. You arrive at this answer by adding the results from each of the three different parts of the statement. Here are two ways to calculate this:
Net cash flow = Cash Flows from Operating Activities + Cash Flows from Investing Activities + Cash Flows from Financing Activities
Net Cash Flows = CFO + CFI + CFF
If Net Cash Flow Is Low or Negative
As outlined above, a company that has weak net cash flow or negative net cash flow possibly could be in trouble. However, although a company can't sustain poor net cash flow for indefinite periods, a few months of these types of results may not be a sign of danger, especially if there's a good reason for the results.
For example, a company could have low net cash flow because it's investing in expensive new equipment, or is paying for a new manufacturing facility. In these cases, the potential upside once the new equipment or facility begins generating revenue may well outweigh the downside of a temporarily poor balance sheet.
However, a net cash flow that's getting smaller month after month could indicate falling sales or a decrease in profit margin, which obviously aren't good signs for a business. If you are managing a business, make sure you understand how to calculate the net cash flow to ensure your business is as profitable as you think it is.