How to Calculate Cash Flow

Let's first cover different types of cash flow, including operating, investing, and financing cash flows, and then provide a step-by-step guide to creating a cash flow statement.

What is Cash Flow?

Cash flow refers to the net amount of cash being transferred into and out of a business. It includes all cash receipts (inflows) and cash payments (outflows) over a specific period. Positive cash flow indicates that a company is generating more cash than it is spending, while negative cash flow suggests the opposite.

Types of Cash Flow

1. Operating Cash Flow (OCF): This measures the cash generated from regular business operations. It includes items such as revenue from sales, payments to suppliers, salaries, and taxes. For example, if a company earns £50,000 in sales but spends £30,000 on operating expenses, the operating cash flow would be £20,000.
2. Investing Cash Flow (ICF): This reflects cash used for or generated from investments in assets, such as purchasing equipment, property, or securities. For instance, if a business buys a new machine for £10,000, this amount would be recorded as an outflow in the investing cash flow.
3. Financing Cash Flow (FCF): This includes cash received from or paid to investors and creditors. Examples include issuing shares, taking out loans, and paying dividends. If a company raises £100,000 through equity financing but repays £20,000 of its debt, the net financing cash flow would be £80,000.

What is Cash Burn?

Cash burn refers to the rate at which a company uses its cash reserves to cover operating expenses before generating positive cash flow from its core business operations. This metric is especially important for startups, which may not yet be profitable. Understanding your cash burn rate helps determine how long your company can sustain its operations before needing additional funding. A high cash burn rate may indicate inefficiencies or unsustainable spending, while a manageable cash burn rate suggests that the company is on a sustainable growth path. The cash flow statement can help you understand where you stand with cash burn.

Example of Cash Burn

Imagine a tech startup called "TechNova" that develops software solutions. TechNova is currently in its growth phase and is focusing on expanding its product offerings and acquiring new customers. Here’s a simplified breakdown of TechNova's monthly cash burn:

• Revenue: £50,000
• Operating Expenses:
  • Salaries: £30,000
  • Rent and Utilities: £5,000
  • Marketing and Advertising: £10,000
  • Software and Tools: £2,000
  • Miscellaneous Expenses: £3,000
• Total Operating Expenses: £50,000

In this scenario, TechNova's revenue covers the operating expenses exactly, resulting in a net cash flow of £0 for the month. However, let's assume that in the following months, revenue stays the same while they invest more heavily in marketing and product development to accelerate growth.

• Increased Marketing and Advertising: £15,000
• New Product Development Costs: £5,000

Now, the total operating expenses increase to £60,000, but the revenue remains at £50,000. This results in a negative cash flow of £10,000.

Cash Burn Calculation:

• Monthly Cash Burn Rate: £10,000 (the amount by which expenses exceed revenue)

Implications:

TechNova's cash burn rate indicates that they are spending £10,000 more per month than they are earning. If they have £100,000 in cash reserves, they have 10 months of runway before they need to secure additional funding or significantly cut expenses to sustain their operations. This period, known as the "runway," is critical for planning and decision-making. The cash burn rate helps the company's management understand how long they can continue operations at the current spending rate without additional funding.

How to Calculate Cash Flow

To calculate cash flow, you typically need to create a cash flow statement, which provides a detailed overview of cash inflows and outflows across operating, investing, and financing activities. Here’s a simplified guide:

1. Calculate Operating Cash Flow (OCF): Start with your net income, then add back non-cash expenses like depreciation and amortisation. Adjust for changes in working capital, such as accounts receivable, accounts payable, and inventory levels.
2. Calculate Investing Cash Flow (ICF): Sum up the cash spent on purchasing assets and deduct cash received from selling assets. This includes transactions like buying equipment, acquiring property, or selling investments.
3. Calculate Financing Cash Flow (FCF): Add cash received from issuing shares or taking out loans, and subtract cash used to repay debts or pay dividends to shareholders.
4. Combine the Cash Flows: Add the net amounts from operating, investing, and financing activities to determine the total cash flow. This gives you an overall picture of how cash is moving in and out of your business.
5. Adjust for Opening Cash Balance: Finally, add the opening cash balance (the amount of cash at the beginning of the period) to the total cash flow to find the ending cash balance. This shows the total cash available at the end of the period.

Example of a Cash Flow Statement

Here's a simplified example of a cash flow statement:

• Operating Cash Flow:
  • Revenue: £50,000
  • Operating Expenses: £30,000
  • Net OCF: £20,000
• Investing Cash Flow:
  • Purchase of Equipment: £-10,000
  • Net ICF: £-10,000
• Financing Cash Flow:
  • Equity Financing: £100,000
  • Debt Repayment: £-20,000
  • Net FCF: £80,000
• Total Cash Flow: £90,000
• Opening Cash Balance: £10,000
• Ending Cash Balance: £100,000

Conclusion

Calculating cash flow is a fundamental aspect of managing your business's finances. By understanding and monitoring cash flow, you can ensure that your startup or small business remains financially healthy and prepared for future growth. Regularly reviewing your cash flow statement allows you to make informed decisions, plan for the future, and address potential issues before they become critical.