Cash flow is a term you might hear when discussing business, but did you know it pertains to your personal finances, too?
Business cash flow refers to incoming and outgoing money in a company, and its profit is what’s left over. Savvy business owners know how to calculate cash flow. This same concept can help you manage your personal budget.
Cash flow can be divided into two categories: free cash flow and operating cash flow. Whether you’re interested in tracking your personal cash flow or need to calculate your business’s operating cash flow, here’s a short guide to get you started.
Free Cash Flow vs. Operating Cash Flow
Free cash flow is what you have to spend after your household costs have been deducted. Operating cash flow refers to money you track for business purposes. Knowing how to track both is key to your financial success. Free cash flow is money you can spend after your earmarked expenses have been deducted.
By monitoring your bank account closely (sign up for online banking) and tracking your expenses (try a budget app), you’ll be able to clearly see how your personal cash flow is being spent.
How to Calculate Free Cash Flow
Just as business owners calculate their business cash flow, you can also figure your personal cash flow. To calculate your free cash flow, you’ll need to calculate your income, fixed expenses and variable expenses.
- Income: Include all sources of income such as your paycheck and other sources, including child support, government benefits, interest or dividends received.
- Fixed expenses: These are bills you pay annually or monthly, such as mortgage and car payments, that do not vary during any given month.
- Variable expenses: These are just what you’d expect. These expenses vary per month and include groceries, utilities, car repairs, entertainment, clothing, etc. These are not specific bills, but rather, expenses that fluctuate from month to month.
Free Cash Flow Formula
Once you have all this information on hand, subtract your expenses (including fixed and variable expenses) from your income, and what’s left is your net cash flow:
Cash Inflow - Cash Outflow = Net Cash Flow
Your cash inflow is your net income. Cash outflow is your fixed and variable bills. What’s left at the end of the month is your net cash flow. This is money you can use to pay off debts and save. Here’s an example of how the free cash flow formula works:
Jane Brown nets $60,000 per year through income. Her cash outflow (variable and fixed expenses) is 40,000 per year, leaving her with a net cash flow of $20,000.
Cash Inflow: $60,000
Cash Outflow: $40,000
Net Cash Flow: $20,000
Once you start tracking your free cash flow, you’ll be able to clearly see how much money is needed to keep your house up and running each month.
Your goal is to have a positive cash flow each month, which means you’ll be able to pay your bills on time, in full, without borrowing in the form of a loan or using credit cards. Note: the available balances on your credit cards do not count as free cash flow — what you spend using credit cards translates into negative cash flow or debt until they are paid off in full.
How to Calculate Operating Cash Flow
If you own a business, you need to track your operating cash flow. Even if it’s just a small side business, such as selling cupcakes or providing clerical services, every penny counts. It’s important to keep a tangible record for income tax purposes, and these days online tracking makes the most sense rather than paper documents. By keeping accurate financial records on your computer, you can easily access information for business colleagues, accountants, and tax preparers.
The formula for determining operating cash flow is as follows:
Net Income + Non-Cash Expenses - Increase in Working Capital = Operating Cash Flow
In other words, start with the net income your business generates. Start with total profits minus expenses such as the cost of goods, utilities, marketing and payroll. This will give you your net income. Next, add in non-cash expenses such as depreciation of equipment (such as computers). Here’s an example:
John Smith owns an auto repair business with $125,000 in net profit. He has a balance of $75,000 in uncollected debt from customers. He owes $15,000 to vendors and suppliers. He bought a tow truck that depreciates at $6,000 per year. Here’s what John’s Operating Cash Flow statement looks like:
Net Income: $125,000
Non-Cash Expenses: $6,000
Changes in Working Capital: $ (75,000 accounts payable) + $ 15,000 accounts receivable
Net Operating Cash Flow: $ 71,000
Of course, there are other factors that can impact John’s business such as outstanding loans he’s paying off. Those are separate figures that need to be figured in to accurately assess his true operating cash flow. But on the surface, John’s company is profitable. You can apply this basic formula to your business to track your success and growth.
How to Use a Spreadsheet to Calculate Cash Flow
If you use a spreadsheet to calculate your cash flow, you’ll be able to better visualize your spending habits. Check out this spreadsheet courtesy of the U.S. Small Business Association.
Separate columns by month and list each expense on the left to tally up your income and expenses. Be sure to list all expenses, including those that are quarterly or annual, such as property taxes, driver’s renewal fees and gym memberships.
Positive Cash Flow is Key
Calculating your cash flow enables you to see where your money goes and any financial mistakes you may be making. Do you have enough in savings to cover a $400 emergency? Track your budget using a spreadsheet and use tools such as a budget app so you’ll likely save more and be prepared for an emergency.
Running a household is much like running a business — and you’re the CEO.
By making smart financial moves and monitoring your spending closely, you’ll increase your chances of having positive cash flow and more extra money at the end of the month.
Frequently Asked Questions
Is knowing your cash flow important?
Yes, knowing your cash flow as a business is extremely important. Cash flow refers to the movement of money in and out of your business, and it is crucial for the financial health and sustainability of your company. By monitoring and understanding your cash flow, you can effectively manage your expenses, make informed decisions about investments and growth opportunities, and ensure that you have enough funds to cover your operational costs and obligations. Without a clear understanding of your cash flow, you may encounter cash shortages, struggle to pay bills or employees, and even risk the survival of your business. Therefore, regularly tracking and analyzing your cash flow is essential for the success and longevity of your business.
Why is knowing cash flow important?
Knowing cash flow is important because it allows businesses to understand and manage their financial health. Cash flow refers to the movement of money in and out of a business, and it is crucial for determining whether a company has enough funds to cover its expenses, pay its employees, invest in growth, and meet financial obligations. By tracking cash flow, businesses can identify potential cash shortages or surpluses, make informed decisions about spending and investment, and plan for future financial needs. Without a solid understanding of cash flow, businesses may struggle with liquidity issues, miss out on growth opportunities, or even face insolvency.
Is cash flow the most important thing?
Cash flow is certainly important for any business, as it ensures that there is enough money coming in to cover expenses and keep the business running smoothly. However, it is not the only factor to consider. Other factors such as profitability, customer satisfaction, and growth potential also play a significant role in the success of a business. Ultimately, a balanced approach that takes into account multiple aspects of the business is crucial for long-term success.