What does net cash flow mean?

Revolut Contributor

 · 07/30/2020  · 07/30/2020

The net cash flow of a business is the aggregate effect of its cash inflows and cash outflows over a given period. If total cash receipts are greater than the amount of cash which leaves its coffers during this time, the net cash flow is positive. If the opposite is true, the business has a negative cash flow.

What is net cash flow?

To define net cash flow, we must first understand the basic premise of a cash flow statement. This document reveals the amount of cash available to a business over a period – for instance, a quarter or a year – and measures its liquidity.

Each statement shows the cash balance of the business at the start and finish of the period it covers. In simple terms, this balance is the amount of cash held in the bank. However, a cash flow statement should also include near-cash assets (i.e. anything readily convertible to known amounts of cash, such as bonds or hunks of gold bullion).

The cumulative effect of these movements is the net cash balance. Should the net cash flow in this period be positive, the business will add to its balance of cash assets, and if this number is negative, that pot of delicious liquidity will diminish. We look at the concept of positive cash flow here.

How to calculate net cash flow?

If a business does not prepare cash flow statements – and these are not compulsory for smaller firms – there is an easy way to gain a snapshot of net cash flow. The secret is to compare the change in the amount of cash shown on its balance sheet from one period to the next.

Be wary of the balance sheet version of the net cash flow definition because this trick is only ever an approximation and is not a reliable figure. It’s much wiser to create an accurate cash flow statement.

This post will focus on what net cash flow means. We discuss how to calculate cash flow here.

How to work out net cash flow?

The net cash flow formula relies upon a grasp of the three sections in a cash flow statement, as  shown below:

  • Operating cash flow (i.e. activities related to operations e.g. sales revenue or supplier costs)
  • Investing cash flow (i.e. activities related to investment e.g. purchase or sale of machinery)
  • Financing cash flow (i.e. activities related to providers of capital e.g. long-term loans)

Once you see that these elements are the building blocks of a cash flow statement, the net cash flow equation becomes crystal clear:

Net cash flow = Operating cash flow + Investing cash flow + Financing Cash Flow

What does net cash flow reveal about a business?

This metric shows whether or not the business will meet its financial obligations over a given period. Investors are deeply curious about the net cash flow of a business because this figure often reveals whether it requires short-term funding to prop up the whole operation.

Nevertheless, the net cash flow cannot by itself prove that the business is in rude financial health, as cash flow and profitability are only distant cousins. These metrics are related, yes, but not siblings.

One common error is to confuse net cash flow with net income. The latter is another way to say net profit, which is the amount of revenue that remains once the business deducts all of its costs. The net income figure is the bottom line of the profit and loss statement. By contrast, the net cash flow merely quantifies the movement of cash in the same period. Not the same thing.

Should the cash flow be positive or negative?

On the whole, positive is better than negative. Remember that a positive cash flow does not indicate if the business makes a profit. This surplus liquidity could be due to other factors, such as the influx of new loan capital or cash receipts for selling stock at a loss. The business might also have declared chunky dividends to the shareholders that it has not yet paid out.

The flip-side is that negative cash flow does not always mean a business is on its uppers. There could be a credible reason, such as payment for costly machinery, which will eventually turbo-charge profits. While it’s wise to watch net cash flow, this liquidity metric only hints whether a business is hot or not.

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