What is net cash flow and why does it matter?

Net cash flow is the amount of money that flows through a company in a set period - and it’s an effective way to keep track of the health of your business, in addition to predicting its future viability.

To understand net cash flow in its simplest form, this short guide breaks down what the metric is, why it’s important, and how you can implement it in your business strategy.

What is net cash flow?

Net cash flow is a way to measure how much money a business has handled during a set period. It’s the difference between monetary incomings and outgoings.

The funds that net cash flow measures come from three primary sources:

• Standard business operations
• Investment returns
• Any financial assistance (loans)

When incoming funds outweigh outgoing funds, your business has ‘positive cash flow’. But when the opposite is true, your business has ‘negative cash flow’.

When it comes to cash flow vs profit, the difference is that profit represents the funds remaining once all business overheads and bills have been paid, whereas cash flow indicates the amount of money moving through your business.

Positive vs. Negative Net Cash Flow

Positive net cash flow means your business is bringing in more money than it is spending. With extra cash on hand, you can invest in growth opportunities such as new projects or equipment, repay debts more easily, and build a reserve for unexpected expenses. It also supports strategic planning and business expansion, ensuring financial stability and making it easier to attract investors or secure loans.

Negative Net Cash Flow

Negative net cash flow indicates that your business is spending more money than it is receiving. This can signal potential financial issues that you need to address.

It may lead to difficulty covering operational expenses, struggles with debt obligations, and liquidity challenges. To address this, you may need to implement cost-cutting measures and reevaluate strategies to boost revenue and reduce expenses. 

Net Cash Flow vs. Overall Cash Flow

Net cash flow is the difference between your total cash inflows and outflows over a period. It helps assess the financial health of your business by indicating liquidity and operational efficiency. 

Overall cash flow encompasses all cash inflows from various sources without deducting outflows. It provides a comprehensive view of your business's cash movements, which is crucial for managing total cash availability and long-term financial planning. Overall cash flow shows the total amount of cash generated by your business and aids in resource allocation for operations, investments, and debt repayment.

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How to use net cash flow

Net cash flow is a vital metric for understanding the financial health of a business. It measures the difference between the money flowing into the business and the money flowing out over a specific period. This information provides several key benefits:

Understanding Financial Health

Net cash flow offers a clear picture of your business's liquidity. Positive net cash flow indicates that your business is generating more cash than it is spending, which is a strong indicator of financial stability and growth potential. Conversely, negative net cash flow can signal potential financial troubles that need to be addressed promptly.

Informed Budgeting and Spending Decisions

By regularly tracking net cash flow, business owners can make more informed budgeting decisions. It helps you identify trends in your cash flow, understand the timing of cash inflows and outflows, and anticipate future cash needs. This foresight enables better planning and allocation of resources, ensuring that your business has the funds necessary to cover expenses and invest in growth opportunities.

Meeting Financial Obligations

Net cash flow is crucial for ensuring that your business can meet its short-term and long-term financial obligations. It provides a realistic view of how much cash is available to pay for essentials like bills, salaries, and supplies. Maintaining positive net cash flow ensures that you can keep your operations running smoothly and avoid the financial strain caused by unexpected expenses or revenue shortfalls.

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What are the components of net cash flow?

As mentioned above, net cash flow is derived from three primary sources: operating activities, investing activities, and financing activities. Understanding these components helps provide a comprehensive view of where your cash is coming from and where it is going.

Operating Activities

Operating activities encompass the core business operations that generate revenue. This includes cash received from customers, payments made for supplies, salaries, rent, and other operating expenses. 

For example, if a retailer receives £100,000 from sales and pays £60,000 in expenses, the net cash flow from operating activities would be £40,000.

Investing Activities

Investing activities involve the purchase and sale of long-term assets and investments. This could include money spent on acquiring new equipment, purchasing real estate, or investments in stocks and bonds. Conversely, it also includes the cash received from selling these assets. 

For instance, if a business spends £30,000 on new machinery but sells some old equipment for £10,000, the net cash flow from investing activities would be -£20,000.

Financing Activities

Financing activities pertain to transactions that affect the equity and debt of the business. This includes cash received from issuing shares or obtaining loans, as well as cash paid out to repay loans or buy back shares. 

For example, if a business takes out a £50,000 loan and repays £20,000 in existing debt, the net cash flow from financing activities would be £30,000.

What information do I need to calculate net cash flow?

Accurate calculation of net cash flow requires a thorough understanding of your financial transactions. Here are the essential documents and data needed:

• Income Statement: Provides details on your revenue, expenses, and profits over a specific period.
• Balance Sheet: Offers a snapshot of your business’s financial position, including assets, liabilities, and equity.
• Cash Flow Statement: Summarises the cash inflows and outflows from operating, investing, and financing activities.
• Bank Statements: Reflects all the transactions made through your business accounts.
• Invoices and Receipts: Documents cash received from customers and payments made to suppliers and other expenses.

How to calculate net cash flow

Net cash flow is surprisingly simple to calculate;  all you need to do is find the difference between the amount of cash entering and leaving your business in a set period:

Net Cash Flow = Inflowing Cash – Outflowing Cash

So, if your business had a total cash inflow of £50,000 and a total cash outflow of £35,000 in a given quarter, the equation would become:

Net Cash Flow = £50,000 – £35,000

In this case, net cash flow would be £15,000, indicating the business has positive cash flow.

It’s also possible to work out net cash flow by combining the cash generated from the sources outlined above. For example:

Net Cash Flow = Cash from Business Operations + Cash from Investment Returns + Cash from Financial Assistance

So, if your business generated £50,000 from business operations, and £20,000 from investments, but had to repay £15,000 in loans, the net cash flow formula would become:

Net Cash Flow = £50,000 + £20,000 – £15,000

In this case, net cash flow would be £55,000, indicating that the business has positive cash flow.

Remember, it’s important to measure net cash flow during various time frames to avoid generating biased results. Try to calculate both monthly and annually, as this will give you the most accurate information on cash trends within your business and will allow you to predict viability in the long and short term.

Cash Flow Support When You Need It

Managing net cash flow effectively is crucial for the success and stability of your business – and if you need support, a short term business loan can give you the room you need to manoeuvre. 

With flexible terms and quick access to funds, our Flexi-Loan helps you bridge cash flow gaps, cover unexpected expenses, and invest in growth opportunities. Find out how much you can borrow with our no-obligation business loan calculator.

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