How to calculate net cash flow (and why it's important)

By Indeed Editorial Team

Updated 10 December 2022

Published 19 May 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Net cash flow can be a useful indicator of how well a business is doing. This figure represents how much cash a business has gained or lost over a particular period of time. Understanding how to calculate cash flow is very useful if you're interested in understanding a company's financial health. In this article, we explain how to calculate net cash flow, why this calculation is so useful, some example calculations and the answers to some frequently asked questions.

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How to calculate net cash flow

Understanding how to calculate net cash flow is quite intuitive. It's simply the amount of cash that a business receives minus the amount of cash that it loses over a specified period of time. For instance, you might calculate net cash flow daily, weekly, monthly or quarterly. There are two formulae for calculating net cash flow (NCF), namely an extended one and a simpler one. The simpler one, which can be used to calculate some specific cash flows, is as follows:

net cash flow = total cash inflows - total cash outflows

There's also the extended formula, which typically requires you to have already calculated the cash flow for some of the components of its formula. The extended formula is as follows:

net cash flow = net cash from operating activities + net cash from investing activities + net cash from financial activities

A company's operating activities are the net income it derives from selling its basic products and services. In many cases, this might be the largest source of income for a business, although this depends on the nature of the industry. Net cash from investing activities means cash that's derived from a company's investments, such as investments in real estate, derivatives or similar. Lastly, the net cash from financial activities means money that's received from taking out a loan, minus any loan repayments.

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Why net cash flow is important

The net cash flow of an organisation is an indicator of its financial health, and therefore an important piece of information for owners, managers, stakeholders and potential investors. Potential investors who find a company with very good net cash flows are more likely to invest their money into it, whereas if a company's net cash flows are consistently negative, then they're much less likely to do so.

It's important to remember that net cash flow can fluctuate a lot more than other things like net profit, so investors and others are going to be interested in seeing how the figure varies over time. Some of the implications of both positive and negative cash flow are as follows:

Positive net cash flow

When an organisation has positive net cash flow, this means that more cash is entering the business than leaving it, resulting in a surplus. This is a sign of good financial health and also an opportunity, as the surplus cash can be used to improve the business by investing in new staff, machinery or research. A firm might even use surplus cash from a positive net cash flow to make financial investments, therefore potentially improving its net cash flow in the future through greater returns on investments.

Negative net cash flow

If an organisation is experiencing negative cash flow, this severely limits its ability to invest more money into its operations. If the organisation's executives wish to make such investments, they'd probably have to consider seeking a loan. The repayments on a loan would also negatively impact the firm's net cash flows, which could make the problem worse if the money isn't wisely invested in the company's core operations. This situation isn't a very reassuring one for potential investors, who might instead consider alternative companies in which to invest.

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Examples for calculating net cash flow

Below are some examples for how to calculate net cash flow for hypothetical organisations:

Example 1

A firm's executives want to calculate its net cash flow for the month. The main source of income is from selling goods in the retail sector. This has been financed with some loans and the company tends to invest surplus cash in the financial sector. The first step is to calculate the net cash flow from its retail operations. The company's total inflows from these activities were £100,000 and its outflows were £50,000:

net cash from operating activities = £100,000 - £50,000

net cash from operating activities = £50,000

The next steps are to repeat this process for the firm's investment and financial activities. The firm has a policy of investing 10% of its net operating cash and currently has returns totalling £20,000 for the month. The loan repayments it's still making cost £25,000 per month and there's no inflow of cash from financial activities. The next steps are therefore as follows:

net cash from investment activities = £20,000 - (£50,000 x 0.1)

net cash from investment activities = £15,000o

net cash from financial activities = 0 - £25,000

net cash from financial activities = (-) £25,000

The last step is to derive the total net cash flow. Remember that although 10% of the net cash from operating activities has been reinvested, this figure has already been subtracted from the total. Therefore, the operating activities net cash flow figure remains the same:

net cash flow = £50,000 + £15,000 - £25,000

net cash flow = £40,000

Example 2

The second example is a company in the financial services sector. It provides some paid services to clients and also offers loans. It reinvests a significant proportion of its income when possible. This company has the option of considering the income from loans as an operating activity or a financial one. Since this firm is in the financial sector, it lists income from loan repayments under operating income. The firm is also repaying its own loans, which were used to start up the business some years ago.

This company wants to calculate the figure for a quarter. Its cash income from operating activities was £2 million for this time period, and its outflows were £1.5 million. The first calculation is therefore as follows:

net cash from operating activities = £2,000,000 - £1,500,000

net cash from operating activities = £0.5 million

Next, the company considers its income from investments. The policy is to reinvest 50% of net cash inflows. It also has income from investments totalling £250,000. The calculation is therefore done like this:

net cash from investing activities = £250,000 - (£250,000 x 0.5)

net cash from investing activities = £125,000

After that, the firm considers its loan repayments. Since there are no financial activities inflows, as this is considered part of the operating inflows, there's simply a negative figure of £250,000 to account for in the final calculation:

net cash flow = £500,000 + £125,000 - £250,000

net cash flow = £375,000

Net cash flow frequently asked questions

Below are some frequently asked questions regarding net cash flow, together with their respective answers:

How is net cash flow different from net profit?

The primary difference is that net profit includes all forms of income and money inflows, whereas net cash flow only considers cash. So, any customers who are paying for their purchases in ways other than up-front cash aren't going to be considered when calculating net cash flows. If they made a smaller up-front payment in cash and paid the rest over a period of time in instalments, then only the cash figure would be considered. Conversely, net profit might include these. Additionally, net profit considers a lot of other non-cash calculations, such as depreciation.

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Is negative cash flow always a bad thing?

No. There are certain limitations to the net cash flow calculation. For example, a business might be in a position to repay its debts rapidly over a short period of time. This may involve considerable sums of cash flowing out of the business over a few months, after which the debt would be totally repaid. During these months, the business might report consistently negative net cash flows which could appear to indicate trouble for the organisation, but in reality the reverse is true.

The same is true if the business starts investing large sums of cash. The delay for receiving returns on these investments, in addition to the significant outflows of cash, might cause a negative cash flow. In this case, that's not necessarily a bad thing, as the business is financially healthy enough to make investments on a substantial scale.

Is net cash flow the most important consideration for potential investors?

No. Investors are usually aware of how a negative cash flow might still be a good sign, depending on the specific nature of a company's outflows. Instead, they might be interested in the operating cash flow (OCF), which is simply the cash flows from a company's primary operations. This is the core activity of a business and the cash it can generate is a more useful indicator of financial health. Net profit (or net income) is also typically more relevant to potential investors than net cash flow.


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