Anyone who wants to calculate cash flow should first know what is meant by the term and what methods can be used to perform a calculation. Cash flow, also known as capital flow, provides information on the earnings and financial power of a company. This is particularly important for lenders and investors as well as shareholders of a company. Cash flow can be improved by appropriate financing measures (e.g. factoring, inventory financing).
In the following article, we would like to define what is meant by cash flow, when we speak of a positive or a negative cash flow and what the differences are with the terms liquidity and profit. Furthermore, we go into the different calculation methods as well as formulas and try to better illustrate the topic with practical examples.
Definition: What is meant by cash flow?
The term cash flow refers to the flow of funds (also capital flow) of a company within a defined period of time, i.e. the difference between income and expenses.
Definition: Cash flow indicates a surplus that results when expenses are deducted from revenues. It provides information on the extent to which a company has generated financial resources from its own resources. The ratio shows the extent to which the company can finance itself from within (internal financing) and the financial potential that grows from successful operations.
Cash flow is usually calculated for a fiscal year, but monthly and quarterly calculations are also possible.
The definition shows that cash flow reflects the internal financing power of the company : The more capital is generated by the company itself, the less borrowed capital (e.g. bank loans) has to be used. The surplus generated can remain in the bank account and strengthens solvency; it can also be used to make further investments or repay a loan. Cash flow calculations are often used to assess the liquidity and financing capacity of a company, as this calculation is less abstract and, in contrast to the balance sheet, more difficult to manipulate in the sense of “balance sheet cosmetics”.
What information does the cash flow contain?
In the course of determining profits in annual financial statements (balance sheet), both cash and non-cash expenses and income are included.
Entries are considered cash-effective if they are available cash (liquid funds) (e.g. wage and salary payments, revenue from the sale of goods).
Non-cash entries are those where there is no actual cash flow (e.g. provisions, depreciation and amortization).
- Balance sheet: cash and non-cash entries.
However, cash flow only takes into account cash-effective bookings, so this ratio retains information on the real internal financing, liquidity and solvency of a company.
- Cash flow: Cash-effective postings only.
Cash and non-cash postings
Before you can calculate cash flow, you should know what cash and non-cash entries are.
- Non-cash entries are those entries that are deferred in time, e.g. depreciation and amortization, write-ups, inventory reductions, extraordinary expenses or income, reserves and provisions, and their reversal. They have no direct relation to cash flow.
- Cash-effective entries , on the other hand, are entries that represent liquid funds and are available cash. An actual cash flow exists, e.g. personnel expenses, payments received from receivables or sales.
| Income | Expenses | |
| Non-cash postings | – Attributions – Provision reversal – Extraordinary income | – Depreciation – Increase in provisions – Inventory reduction – Extraordinary expenses |
| Postings affecting payments | – Receivables paid in – Sales deposits | – Personnel costs – Payment of liabilities – Cost of goods and materials – Investments – Equity withdrawal – Loan repayment |
Calculate cash flow – What do the key figures mean?
Cash flow is used to determine various key figures of a company:
-
What cash is available?
- Cash flow shows how much money is available to repay debts or pay interest. If cash flow is positive, there are sufficient funds to make outstanding payments.
-
What about competitiveness?
- The cash flow shows whether the company can make investments from its own financial resources (self-financing capability). High cash flow makes the company interesting for investors and other business partners.
-
How high is the risk of insolvency?
- Cash flow provides information about a company’s solvency, over-indebtedness and ultimately its risk of insolvency.
Interpret cash flow: Positive and negative cash flow
Cash flow can be either negative or positive. A positive cash flow indicates an inflow of cash and cash equivalents, i.e. the company has generated surpluses or profits and has the funds to make investments, repay debts or pay out shareholders.
In the case of a negative cash flow (cash loss, cash drain), it can be seen that funds are flowing out and the company is reducing surpluses or investing money in business. A negative cash flow illustrates a liquidity shortage.
Positive and negative cash flow:Cash flow is said to be positive when cash inflows into a company are greater than cash outflows. With a negative cash flow, outflows are greater than inflows.
The different types of cash flow
Which postings are included in the calculation depends on the cash flow type or model used. However, all cash flow models exclude non-cash entries. These include, for example, write-downs and additions as well as the reversal of provisions.
In the following sections, we take a closer look at the different calculation models and what they mean:
- Operating cash flow / gross cash flow
- Free cash flow / net cash flow
- Cash flow from investing activities
- Cash flow from financing activities
Operating cash flow / gross cash flow
Operating cash flow indicates the extent to which a company is able to finance itself. If current income or incoming payments are higher than current expenses or outgoing payments in a given period, this is referred to as positive cash flow.
Basically, operating cash flow comprises the result of all cash events in the ordinary course of business.
In the analysis of the annual financial statements, it is regarded as an indicator of the company’s internal financing potential. If cash flow is positive, the company can repay loans or make new investments from sales.
Operating cash flow shows the cash inflow surplus from production and sales within a period, whereas total cash flow also captures inflows and outflows triggered by investment, distribution and financing decisions.
In simple terms, operating cash flow shows the actual sustainability of a company’s business idea and is considered an important indicator of the company’s earnings position.
For the calculation of operating cash flow, net income is adjusted for non-cash entries.
Formula for calculation:
Net income after taxes
– Non-cash income
+ Non-cash expenses
________________________________
Operating cash flow
Cash flow from investing activities
Cash flow from investing activities indicates whether a company has made investments or purchased assets. If the cash flow is positive, i.e. there is money available from operating activities, the company has the opportunity to make investments.
This form of cash flow is the cash inflows and outflows that have occurred as a result of the company’s investments. The difference between these payments indicates whether the investing activities carried out in the financial year resulted in positive or negative returns to the company. Included here are acquisitions and sales of fixed assets and other investments that are not made at regular intervals.
If you want to calculate this cash flow, you have to determine the difference between the cash inflows and outflows of the profits or losses generated by investments.
Formula for calculation:
Proceeds from disposals of financial assets
– Payments for investments in fixed assets
– Cash outflows for investments in financial assets
_______________________________
Cash flow from investing activities
Cash flow from financing activities
Cash flow from financing activities shows whether a company has taken out or repaid loans or made payments to shareholders or received payments from shareholders. Wage payments to companies also count as such withdrawals.
This form of cash flow includes all cash flows that relate to changes in equity in a company (e.g. share issues, payment of profit shares or dividends) and shows the relationship between equity and debt. Taking out loans or drawing on the overdraft facility provides new liquidity.
Together with cash flow from investing activities and cash flow from operating activities, cash flow from financing activities constitutes total cash flow.
Formula for calculation:
Proceeds from additions to equity
– Payments to company owners and minority shareholders
+ Proceeds from borrowings and loans
– Cash outflows from the redemption of bonds and loans
_______________________________
Cash flow from financing activities
Free cash flow / net cash flow
Free cash flow shows the company’s cash position at the end of a financial period. Free cash flow is basically the money that is available to the company as “free cash” to repay loans, buy back shares or repay debt. In short, free cash flow shows how much money is available to the company and is therefore of particular interest to lenders.
Manipulating free cash flow is almost impossible, but some companies prefer to make major investments or postpone them to a later date in order to influence cash flow accordingly. If you want to calculate free cash flow, you have to exclude investing activities. For this purpose, all investment costs are deducted from the net cash flow.
Formula for calculation:
Operating cash flow
– Cash flow from investing activities
_______________________________
Free cash flow
Cash flow vs. profit and liquidity
Cash flow is calculated on the basis of cash receipts and cash payments, but must not be compared or confused with profit, as no fictitious expenses are taken into account in the calculation of cash flow.
Likewise, a distinction must be made between cash flow and liquidity, because liquidity refers to a specific point in time, whereas cash flow measures a change over a period of time.
Methods: How to calculate cash flow?
There are two different methods for calculating cash flow:
- Direkte Methode: Differenz zwischen Einzahlungen und Auszahlungen innerhalb eines bestimmten Zeitraums. Es werden alle Zahlungsmittelabflüsse (z. B. Löhne, Gehälter, Materialkosten, Steuern) von den Zahlungsmittelzuflüssen (z. B. Umsatz- und Verkaufserlöse, Subventionen) abgezogen:
- Cash flow = Cash inflows – Cash outflows
- Indirekte Methode: Weiterführung der Gewinn- und Verlustrechnung (GuV) des Unternehmens.
- Cash flow = balance sheet profit + non-cash expenses – non-cash income.
The direct method
In the direct calculation, cash flow is the difference between all cash entries (income and expenses). Although this method is a more accurate statement of cash flows, it is not widely used by companies.
+ Cash-effective income
– Cash expenses
= Cash flow
Example
A simple example of the direct calculation method might look like this:
| 2016 | |
| Cash receipts from customers for the sale of products, goods and services | 999,00 |
| Payments to suppliers and employees | – 225,00 |
| Other cash inflows not attributable to investing and financing activities | + 30,00 |
| Other cash outflows not attributable to investing and financing activities | – 50,00 |
| Cash inflows or outflows from extraordinary items | – 170,00 |
| Operating cash flow | 584,00 |
The indirect method
For the indirect calculation method, items that are not cash-effective are eliminated from net income.
Net income
– Non-cash income
+ Non-cash expenses
= Cash flow
The calculation is based on the company’s balance sheet profit on the basis of the annual financial statements after taxes. All non-expenditure expenses are added, i.e. those that have no impact on liquidity and payment, e.g. depreciation (amortization of expense). By contrast, revenue-neutral income is deducted.
Example
A simple example of the calculation of cash flow using the indirect method can be as follows:
| 2016 | |
| Net income | 799,00 |
| Depreciation and amortization (+) | 280,00 |
| Attributions (-) | – 130,00 |
| non-current provisions (+) | + 50,00 |
| non-current provisions (-) | – 170,00 |
|
Operating cash flow | 829,00 |
Discounted cash flow method
The discounted cash flow method determines the enterprise value, whereby the goodwill results from discounting several forms of cash flows. The DCF method is one of the overall valuation methods and is based on the payment surpluses with cash flows and cash flows determined within corporate planning.
The calculation takes into account taxes payable, such as corporate income tax, trade tax and income tax. The result is the discounted cash flow.
Calculate cash flow – free calculation table in Excel
The spreadsheet is perfect for a cash flow calculation. You can create a template yourself and enter your desired variables or download a pre-made one from the Internet. These tables are usually fully functional, unlimited usable, freely customizable and arbitrarily expandable.
Improve cash flow – What are the options?
A company has several options to improve cash flow. On the one hand, production can be based on specific customer demand: The lower the surplus, the lower the manufacturing and storage costs. Merchandise purchases should be adjusted to current customer needs and excessive inventory should be avoided.
Furthermore, cash flow can also be improved by alternative financing options and improving liquidity through loans. One option would be factoring, in which outstanding receivables are sold to a factoring company. The receivables are thus converted into directly available funds. But inventory or merchandise financing can also improve cash flow.
Conclusion – Why should you calculate cash flow?
If you want to calculate cash flow, you should first know what types of cash flow there are and which method is best used to perform the calculation. Cash flow indicates whether revenues have exceeded expenses in a specific business period and are therefore considered an indicator of a company’s competitiveness and liquidity rating. Since a different perspective must be taken on a company’s finances in each case, various models help to calculate cash flow.
It can be helpful to look at operating cash flow separately, but this also takes into account subsidies and investments that may have been particularly high in a fiscal period. This may lead to an incorrect assessment of the business activity.
For example, if a start-up receives a higher funding amount in a fiscal year, it will be in a good financial position at the end of the year. However, this does not mean that the company has become economically active. Therefore, a cash flow calculation must also take a look at financing activities. It may therefore be advisable to use at least 3 different cash flow calculations: Operating cash flow, cash flow from investing activities and cash flow from financing activities.
FAQ – Calculate cash flow
What is meant by cash flow?
Cash flow (cash flow) is an indicator of a company’s earnings and financial power and denotes the company’s cash flow within a specific period. It represents the difference between revenues and expenses.
How to calculate the cash flow?
There are different ways to calculate the different types of cash flow. A distinction is also made here between the direct and indirect calculation methods.
Which postings are taken into account when calculating the cash flow?
Unlike the balance sheet, the calculation of cash flow only takes into account cash-effective entries. The non-cash entries, on the other hand, are to be excluded.
What methods do you use when you want to calculate cash flow?
Two methods can be used to calculate the cash flow: The direct and the indirect determination. The direct method calculates the difference between cash inflows and cash outflows: Cash inflows – Cash outflows = Cash flow (adjusted net income (profit)). In the indirect method, a continuation of the income statement of a company corresponds to: balance sheet profit + non-cash expenses – non-cash income = cash flow.
What is positive cash flow?
If revenues are higher than expenses, there is a surplus. This is referred to as positive cash flow.