Table of Contents
- 1 What is Net Cash Flow?
- 2 How can we Calculate Net Cash Flow?
- 3 Difference between Net Cash Flow and Net Income
- 4 Why is the Net Cash Flow Important?
What is Net Cash Flow?
Net cash flow means the amount of cash generated by an operating business over a period of time say one year, six months or nine months. A business generates or invests cash in three main activities which are: (1) Operating Activities (2) Investing Activities and (3) Financing Activities. Net cash flow is the aggregate of cash inflows and outflows from all these three activities. Net cash flow is nothing but the difference between cash inflows and outflows of a business. We also know it as increase / decrease in Cash and Cash Equivalents. Cash equivalents are those assets which are highly liquid and can be swiftly converted into cash and therefore are termed as good as cash many times.
How can we Calculate Net Cash Flow?
Net cash flows can be easily found in the statement of cash flows. You can also determine the number by calculating the changes in cash balance stated in the balance sheet, over two different periods.
Calculate Net Cash Flow from Statement of Cash Flows
We can calculate the net cash flow from the statement of cash flows with the help of following equation.
Net Cash Flow = CFO+CFI+CFF
Cash from Operating Activities (CFO)
This is the net cash, a business generates from the core operations of the business. CFO includes, tax refunds or expenses and changes in working capital. CFO includes net profits adjusted with non-cash expenses and incomes, and changes in working capital. Non-cash expenses are added back to profits and non-cash revenues are deducted.
Cash from Investing Activities (CFI)
This is the net cash generated from sales and purchase of equipment and assets (tangible or intangible) and any other capital expenditure for core operations. It also includes the movement of cash due to investments made outside the company like investing in other businesses, stock market, bonds etc.
Cash from Financing Activities (CFF)
This is the net cash generated from the procurement and repayment of short and long-term debt, issuance of equity, purchase / sale of treasury stock, payment of dividend etc.
It is to be noted that the net cash flow can be positive as well as negative. The best measure of accuracy of net cash flow is it being equal to the changes in cash and cash equivalents. The latter denotes the difference between opening and closing cash balance.
Calculate Net Cash Flow from Balance Sheet
We can also calculate net cash flow from balance sheet. Net cash flow is the difference between cash balance from balance sheet over two consecutive periods.
Net Cash Flow = Cash Balance for 2020 – Cash Balance for 2019
Example of Net Cash Flow Calculation
In the above example for the year 2011,
Cash from operating activities (CFO) is $7,150.1 million
Cash from investing activities (CFI) is $(2,570.9) million
and Cash from financing activities (CFF) is $(4,533.0) million
Hence, the Net Cash Flow for 2011 is CFO + CFI + CFF + Effect of Exchange Rate=
= 7150.1 – 2570.9 -4533 – 97.5 = -51.3 = $(51.3) million
Difference between Net Cash Flow and Net Income
- Many a times, there is confusion between net cash flow and net income. Though they may sound similar, both are diametrically opposite concepts. Net income is the resultant earning an organisation has after adjusting all the operating & non-operating expenses as well as taxes from the total revenue earned. Whereas net cash flow is the aggregate of all the cash generation by the organisation over a period. If an organisation has $200 as net income, it doesn’t imply that it has generated $200 cash in that period. However, if an organisation has net cash flow as $200, it means that it has been able to generate that amount of cash in that period.
- Net income is a result of accrual basis of accounting wherein you recognize all the expenses in the same period of the revenue earned. Net cash flow, on the other hand, we look at the outflow and inflow of cash and cash equivalents during a period.
- In calculation of net income, it is not necessary that all the expenses need to be in cash. Depreciation and amortization are non-cash expenses included in the calculation of net income. For arriving at net cash flow from operations, you only take cash expenses into consideration.
Why is the Net Cash Flow Important?
Net cash flow is the driving force behind an organisation and it facilitates following important activities.
- core business operations,
- investment in new technology
- research and product innovation,
- expansion in new markets,
- repurchase stock,
- increase equity financing
- reducing debt
However, while analysing net cash flow, we don’t just need to see whether it is positive or negative, but we must also see the time frame and the reason behind it. For example, an organisation may have invested a huge sum in purchasing an equipment to manufacture a new product line. The cash flow might turn negative in the short-run because of this move. However, in the long-run this new product could result in increased cash generation for the organisation which will make the cash flows positive. Similarly, Net cash flows can be negative if the organisation has repaid a big portion of debt, but this may not impact its viability in the long-term. Hence, the analysis has to be multidimensional when it comes to net cash flow.
In the above example also, we have a negative cash flow. However, it is more due to capital expenditure, purchase of restaurant business and payment of cash dividends. Though these transactions have brought down the cash levels, it does not necessarily mean that the business is financially unviable.
Taking all these factors into consideration, if an organisation is able to maintain positive cash flow over a long-term, an investor will consider it financially healthy. On the other hand, if an organisation reports negative cash flows consistently, it is a big question on its viability. Inability to meet its day to day expenses related to operations, investments and financing reduces its potential to attract long-term investors.1,2