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Calculating Cash Flow for your Business

Calculating Cash Flow for your Business

With growing uncertainties and fluctuations in the market, businesses are giving more and more emphasis to their cash flow statement, which records cash inflows and outflows during a specified period. By calculating the cash flow for your business, you can find out whether your company is likely to encounter a cash shortfall in future.

Although a budget is crucial for maintaining and improving the financial health of an enterprise, it cannot give us an accurate picture of its liquidity, as cash is often received and spent at different times. Herein lies the importance of the cash flow statement.

This article will give you a brief idea of what a cash flow statement is, the methods used for calculating and forecasting cash flows, and finally, a cash flow calculator.

What Is a Cash Flow Statement for a Business?

A cash flow statement is basically a financial statement that analyzes the amount of cash and cash equivalents generated and used in the operating, investing, and financing activities of a firm during a given period of time.

It reflects how a firm or company manages its liquidity. It includes only those transactions that affect cash receipts and payments. So, non-cash-based transactions like depreciation or write-offs on bad loans are not included in a cash flow statement.

There are 3 main components of a cash flow statement:

  • Cash flow due to operating activities
  • Cash flow due to investing activities
  • Cash flow due to financing activities

Cash generated from business activities like manufacturing, sales, and delivery of company’s products and services are included in operating activities. But costs incurred on long-term capital or investments are not included. Examples of operating activities are:

  • Sales of goods and services
  • Interest payments
  • Payments made to the suppliers of goods and services
  • Payments made to employees (wages and salaries)
  • Rent payments
  • Interest received on loans

If a cash flow statement is calculated under the indirect method, then depreciation, deferred tax, amortization, dividends received, and gains and losses associated with the sale of non-current assets are also included in the cash flow from operating activities.

Investing activities, on the other hand, include the following items:

  • Purchases or Sales of assets like land, buildings, equipment, marketable securities, etc.
  • Loans given to vendors or received from customers
  • Payments linked to mergers and acquisitions.

Financing activities in a cash flow statement include:

  • Inflows of cash from investors like banks and shareholders
  • Outflows of cash in the form of dividends paid to shareholders
  • Payments made for the repurchase of company shares
  • Sale or the repurchase of company stocks
  • Repayment of debt principal (loans)
  • Net borrowings

Financing activities are mainly external activities undertaken by a firm to raise capital, but they also include repayments made to investors. Whenever capital is raised, it is recorded as ‘cash in’ in a cash flow statement and when dividends are paid to investors, it is included as ‘cash out’.

Methods for Calculating Cash Flow for Business

There are two methods of calculating cash flow – direct and indirect. The cash flow from investing and financing activities sections remain identical under both direct and indirect methods. Only the presentation of the operating activities section of the cash flow statement differs under the direct and indirect methods.

Direct Method: Under the direct method, all items of cash payments and receipts such as wages and salaries, payments made to vendors and suppliers, cash receipts from customers, interest income, interest payments, and dividends received are included.

To arrive at the net cash flow from operating activities, total cash outflows are deducted from total cash inflows. Finally, cash from investing and financing activities are added to this figure to get the net increase or decrease in cash flow.

Indirect Method: Under this method, cash flow is calculated by making a few adjustments to the net income figure obtained from the income statement. The income statement is prepared by using accrual accounting concept, wherein revenues and expenses are recorded when they are earned and incurred, and not when they are actually received or paid.

Therefore, the net income does not give us a true picture of the net cash flow from the operating activities. So, a few additions and subtractions are made for cash-based and non-cash based transactions. Any changes in the assets and liabilities are added or deducted from the net income to arrive at the net operating cash flow.

Cash Flow Forecasting

Receipt and Disbursement Method: This is the direct method of making a cash flow forecast, wherein all anticipated cash receivables and payables are analyzed to predict cash inflows and outflows. It involves scheduling anticipated payments and receipts of a company into days, weeks, or months, which are then combined for the entire period of time for which the forecast is to be made.

Receipts usually include accounts receivable from recent sales, but can also contain sales of other assets. Disbursements, on the other hand, include accounts payable for recent purchases, dividends and interests on debts, and payroll. A cash flow forecast obtained from the direct method is generally used for the short run, usually for a period of 30 to 90 days.

Indirect Method: There are 3 indirect methods for calculating cash flow forecasts – adjusted net income method (ANI), pro-forma balance sheet method (PBS), and accrual reversal method (ARM).

In the ANI method, cash flow projections are obtained from the ‘operating income’ by making some additions and subtractions on account of changes in receivables, payables, and inventories in the balance sheet.

In the PBS method, forecasts are derived directly from the projected book cash account. The precision of such cash flow projections, therefore, depends on how accurately all other balance sheets are projected. This method is usually employed for making monthly or quarterly forecasts.

The third method, the ARM is somewhat similar to the ANI method. But it employs statistical distributions and algorithms to reverse large accruals and to calculate cash effects in order to obtain cash flow forecasts. This method is more complicated than the ANI and PBS methods. It is suitable for making medium-term projections.

Why is it Important to Project Cash Flow for a Business?

The survival of any business, especially the small enterprises and startups depends on the availability of cash. Cash flow projections are, therefore, important for any company to conduct its business activities smoothly. Some of the important reasons why companies are giving more attention to cash flow forecasting are:

  1. Without enough cash, a company will not be able to pay its suppliers and employees and as a result, all business activities will come to a standstill. Cash flow forecasts help a business to manage its finances more effectively so that enough cash is available for running its operations.


  1. A cash flow projection is basically an estimate of the future financial position of a company. It helps identify a potential shortage of cash so that timely actions can be taken to avoid insolvency.


  1. It is an important component of financial planning. Before undertaking any new business activity, you have to consider its impact on the finances of your company. A cash flow projection is, therefore, required to make sure that future changes do not affect liquidity and solvency of the enterprise adversely.


  1. Nowadays, banks also ask for regular cash flow forecasts if a business has taken a loan. If you are planning to take a business loan, it is better to give your cash flow projections to banks even if they don’t ask for it, in order to assure them of your repaying capacity.


  1. It also helps businesses to keep a track of payments received from customers. If customers are not paying promptly, appropriate steps can be taken to tackle the problem.

Cash Flow Calculator

Image Credit: Mastaxcheltenham.com



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