In theory, cash flow isn’t too complicated—it’s a reflection of how money moves into and out of your business.
Unfortunately, for small business owners, understanding and using cash flow formulas doesn’t always come naturally. So much so that 60% of small business owners say they don’t feel knowledgeable about accounting or finance. But by taking the time to read about these three key cash flow formulas—free cash flow, cash flow from operations, and cash flow forecast—you’re on the right track to feeling more confident about your business finances and controlling your cash flow.
For small businesses in particular, cash flow is one of the most important ingredients in their financial health. One study showed that 30% of businesses fail because they run out of money. Using cash flow formulas can help you prepare for slow seasons and ensure you have enough money on hand before spending on your business.
“It is absolutely critical that any entrepreneur understand what their business working capital needs are and plan ahead to ensure their ability to finance growth,” Colin Darretta, Co-Founder & CEO of Innovation Department, told Forbes. “There are more financing tools than ever before, meaning for those who understand and are prepared, it need not be the catastrophic cash crunch it often is for early-stage businesses.”
Important cash flow formulas to know about:
- 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. Don’t freak out if they look complicated! We’ll go over definitions, calculations, and examples together. Use our free cash flow calculator to follow along. (No account needed!)
1. Free cash flow formula
One of the most common and important cash flow formulas is free cash flow (or FCF).
While a traditional cash flow statement (like the kind you can get from Wave reports) gives you a picture of your business’s cash at a given time, that doesn’t always help with planning and budgeting—because it doesn’t truly reflect the cash you have available, or free to use.
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?
Calculating the cash you have available to spend (via the FCF formula) helps answer those questions and others like them.
How to calculate free cash flow
Calculating your business’s free cash flow is actually easier than you might think. To start, you’ll need your company Income Statement or Balance Sheet to pull key financial numbers.
First, let’s get some important financial terms straight.
- 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 = Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure
Free Cash Flow Example
Let’s take a look at an example of that formula in the real world. 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)
So Randi’s free cash flow is represented by:
[$80,000] + [$0] – [-$10,000] – [$2,500] = $67,500
That means she has $67,500 in available cash to reinvest back into her business.
Looking for more details on Free Cash Flow formula? Read here.
2. Operating cash flow formula
Knowing your cash flow from operations is a must when 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.
For example, if you’re looking to secure outside funding from a bank or venture capital firm, they’re more likely to be interested in your operating cash flow. The same goes if you begin working with an accountant or financial consultant, so it’s important to understand what OCF looks like for you before seeking funding.
How 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
Operating Cash Flow Example
To apply the cash flow from operations formula to our previous example (Randi, our favorite freelance graphic designer), let’s say her financials for the year look like this:
- 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.
Looking for more details on the operating cash flow formula? Read here.
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3. Cash flow forecast formula
While both 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.
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.
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.
The formula looks like this:
Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash
- Beginning cash is, of course, how much cash your business has on hand today—and you can pull that number right off your Statement of Cash Flows.
- Project 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.
Getting back to our 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.
Want to create a more detailed cash forecast for the upcoming quarter? Check out our article that walks you through the process of creating a comprehensive cash flow projection.
Cash flow formulas: Math to manage your cash flow
As a small business owner, calculating cash flow formulas may not be what gets you fired up—but running out of cash isn’t a problem any business owner wants to face.
Keeping track of cash flow into and out of your business means you have a more holistic understanding of your business’s financial health. You can anticipate cash flow problems and solve them before they hit, and you can optimize your operations so cash flow troubles become a thing of the past.
If you need more cash flow formula support, visit our cash flow education centre.
