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fulfin - financing ecommerce November 24, 2021 8 Minutes
Categories: Finance - Categories | Financing Guide

Anyone who wants to calculate the cash flow should first know what is meant by the term and which methods can be used to perform a calculation. The cash flow, also called capital flow, provides information about the earnings and financial strength of a company. This is particularly important for lenders and investors as well as shareholders of a company. The 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 differences exist to the terms liquidity and profit. Furthermore, we will go into the different calculation methods and formulas and try to better illustrate the topic with practical examples.

Definition: What is cash flow?

The term Cash Flow denotes the Cash flow (also cash flow) of a company within a defined period, i.e. the Difference between income and expenditure

Definition: The cash flow shows a Surplus which results when expenses are deducted from income. 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 activity.

Cash flow is usually calculated for a fiscal year, but monthly and quarterly calculations are also possible. 

The definition shows that cash flow is the internal financing capability of the company is reflected in the capital structure: The more capital is generated by the company itself, the less debt capital (e.g. bank loans) has to be used. The generated surplus can remain in the bank account and strengthens the solvency; however, it can also be used to make further investments or to repay a loan. Cash flow calculations are often used for the Liquidity assessment and financing capacity of a company, since 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 the Determination of profit of a Annual financial statements (balance sheet) are shown both cash Expenses and income as well as non-cash Expenses and income included. 

As cash Entries are considered to be cash if they are available cash (e.g. wage and salary payments, revenue from the sale of goods). 

From non-cash Postings are used when there is no actual cash flow (e.g. accruals, depreciation). 

  • Balance sheet: Cash and non-cash postings.

If the Cash Flow but all-cash postings are taken into account, therefore this key figure Information on real internal financing, Liquidity and Solvency of a company. 

  • Cash flow: Only postings affecting payments.

Postings affecting and not affecting payments

Before you can calculate cash flow, you should know what cash and non-cash entries are. 

  • Non-cash postings are entries that are deferred in time, e.g. depreciation, write-ups, reductions in inventories, extraordinary expenses or income, reserves and provisions and their reversal. They have no direct reference to cash flow.
  • Postings affecting payments on the other hand, are bookings that represent cash and cash equivalents and are available for payment. An actual cash flow exists, e.g. personnel costs, payments of receivables or sales. 

IncomeExpenses
Non-cash postings- attributions
- reversal of provisions
- Extraordinary income
- amortisation
- Increase in provisions
- inventory reduction
- Extraordinary expenses
Postings affecting payments- debt collections 
- incoming sales 
- personnel costs
- Payment of liabilities 
- Cost of goods and materials 
- investments
- equity withdrawal
- loan repayment

Calculate cash flow - What do the key figures mean?

The cash flow is used to determine various key figures of a company: 

  • What cash is available? 
    • Cash flow indicates how much money is available to repay debts or pay interest. With a positive cash flow, 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 strength (self-financing strength). A high cash flow makes the company interesting for investors and other business partners. 
  • How high is the risk of insolvency? 
    • The cash flow provides information about the solvency, over-indebtedness and ultimately the risk of insolvency of a company.

Interpret cash flow: Positive and negative cash flow

Cash flow can be either negative or positive. In the case of a positive cash flow an inflow of cash and cash equivalents is discernible, i.e. the company has 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) shows that funds are flowing out and the company is reducing surpluses or investing money in business. A negative cash flow indicates a Liquidity bottleneck

Positive and negative cash flow:One speaks of a positive cash flow, when the payments into a company are greater than the expenditures. In the case of a negative cash flow the outflows are greater than the 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 include the Non-cash postings not taken into account. 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

The 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 a positive cash flow. 

Basically, the operating cash flow the Result of all cash events in the ordinary course of business. 

It is considered in the analysis of financial statements as Indicator of internal financing potential of the company. In the case of a positive cash flow the company can repay loans or make new investments from the revenues. 

The 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 simplified terms, operating cash flow shows the actual Sustainability of the business idea of a company and is considered an important Key figure for the earnings situation of the company. 

For the calculation of the operating cash flow, the net income for the year is adjusted for non-cash entries.

Formula for calculation: 

Net income after taxes

- non-cash earnings

+ Non-cash expenses 

________________________________

Operating cash flow

Cash flow from investing activities

The cash flow from investing activities shows whether a company has made investments or purchased assets. If it is a positive cash flow, i.e. there is money from current business activities, the company has the possibility to make investments.

This form of cash flow is the inflows and outflows that have occurred as a result of the company's investments. The difference between these payments indicates whether the investments made in the financial year Investing activities positive or negative recoveries in the company have resulted. Included here are acquisitions and disposals of fixed assets and other investments that are not made at regular intervals. 

Anyone wishing to calculate this cash flow must Difference between incoming and outgoing payments which is due to investments profits or losses made investigate. 

Formula for calculation: 

Proceeds from disposals of financial assets

- Payments for investments in fixed assets

- Payments for investments in financial assets 

_______________________________

Cash flow from investing activities

Cash flow from financing activities

The Cash flow from financing activities shows whether a company has taken out or repaid loans or made disbursements to shareholders or received payments from shareholders. Wage payments to companies also count as such withdrawals. 

This form of cash flow includes all capital flows, which refers to the Changes in equity in a company (e.g. share issues, payment of profit shares or dividends) and shows how the ratio of equity and debt capital is structured. Taking out loans or drawing on the overdraft facility provides new liquidity. 

Together with the Cash flow from investing activities and the operating cash flow the cash flow from financing activities constitutes the total cash flow. 

Formula for calculation: 

Proceeds from equity injections

- Payments to company owners and minority shareholders

+ Proceeds from borrowings and loans

- Payments for the redemption of bonds and loans

_______________________________

Cash flow from financing activitiest

Free cash flow / net cash flow

The free cash flow indicates to the company how the Cash and cash equivalents at the end of a financial period is ordered. Free cash flow is basically the money that is available to the company as "free cash" is available 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 particularly interesting for 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 one would like to manipulate the Calculate free cash flowIf you want to calculate the net cash flow, you have to deduct the 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 using cash receipts and cash payments, but should not be compared or confused with profit, as the calculation does not take into account notional expenses in cash flow. 

Similarly, 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 the cash flow: 

  1. Direct Method: Difference between deposits and withdrawals within a certain period of time. All Cash outflows (e.g. wages, salaries, cost of materials, taxes) are deducted from cash inflows (e.g. revenue and sales proceeds, subsidies):
    • Cash flow = Cash inflows - Cash outflows
  1. Indirect Method: Continuation of the profit and loss account (P&L) of the company.
    •  Cash flow = balance sheet profit + non-cash expenses - non-cash income.

The direct method 

In the direct method, the 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 used very often by companies. 

+ Cash income
- cash expenditure
= cash flow 

Example

A simple example of the direct calculation method might look like this:

2016
Payments received 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 payments not attributable to investing and financing activities– 50,00
Receipts or payments from extraordinary items– 170,00
Operating cash flow584,00

The indirect method

For the indirect calculation method, the items that are not cash-effective are eliminated from the net income. 

  Net income for the year
  - non-cash earnings
  + non-cash expenses
  = cash flow 

The basis of the calculation is the balance sheet company profit on the basis of the annual financial statements after taxes. All expenditure-neutral expenses are added, i.e. those that have no effect on liquidity and payment, e.g. depreciation (write-offs for expenses). By contrast, revenue-neutral income is deducted.

Example

A simple example of the calculation of cash flow using the indirect method may be as follows: 

2016
Net income for the year799,00 
Depreciation (+)280,00
Attributions (-) - 130,00
long-term provisions (+)+ 50,00
non-current provisions (-)– 170,00

Operating cash flow
  829,00

Discounted cash flow method

The discounted cash flow method determines the company value, whereby the company value results from the discounting of 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 the 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 great 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 spreadsheets are usually full-featured, unlimited in use, freely customizable, and can be expanded as needed. 

Improving cash flow - What are the options? 

A company has several options to improve cash flow. First, production can be based on specific customer demand: The lower the surplus, the lower the manufacturing and storage costs. Purchases of goods should be adjusted to the current customer demand and excessive inventories should be avoided. 

Furthermore, cash flow can also be improved by alternative financing options and improving liquidity through loans. One possibility would be factoring, in which outstanding receivables are sold to a factoring company. The receivables are thus converted into directly available funds. However, inventory or goods financing can also improve cash flow. 

Conclusion - Why should you calculate cash flow?

Anyone wishing to calculate cash flow 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 needs to be cast on a company's finances in each case, different models help in calculating cash flow. 

Looking at the operating cash flow separately can be helpful, but it 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 was economically active. Therefore, a cash flow calculation must also take a look at the financing activities. Accordingly, it may 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 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 income 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, only cash-effective postings are taken into account when calculating the cash flow. The non-cash postings, 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 method. In the direct method, the difference between cash inflows and cash outflows is determined: Cash inflows - Cash outflows = Cash flow (adjusted net income (profit)). The indirect method corresponds to a continuation of the income statement of a company: balance sheet profit + non-cash expenses - non-cash income = cash flow. 

What is positive cash flow?

If the income is higher than the expenses, there is a surplus. This is referred to as a positive cash flow.

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