Net cash flow

Key Takeaways:

• Net cash flow is the difference between incoming and outgoing cash in a business from three different areas: operating, financing, and investment activities.
• Understanding net cash flow is crucial for business owners, as it helps to identify periods of high or low cash flow, which can be vital for planning and making financial decisions.
• Calculating net cash flow involves subtracting outgoing cash flow from incoming cash flow over a specific period of time. The formula is Net Cash Flow = CFO (Cash Flow from Operating Activities) + CFI (Cash Flow from Investing Activities) + CFF (Cash Flow from Financing Activities).
• Net cash flow is only one part of the overall picture when assessing a business's health, and it should be considered along with other financial metrics.

Why is understanding net cash flow important?

It is essential to have cash in a business to ensure its day-to-day running costs are covered; otherwise, you could quickly go out of business even if, over a longer period, your business is profitable. However, a positive net cash flow is not necessarily good, and a negative net cash flow is not necessarily bad; it all depends on where the cash has come from or where it is going.

Monitoring cash flow over a particular period is essential for understanding how your business is managing and will manage in the future. It enables you to follow the flow of cash and identify periods when incoming/outgoing costs are higher or lower. This information is crucial for planning, especially when decisions involve cash coming into or leaving the business. Ensuring you are not short of cash in your business could be the key to success.

Cash flow is also vital information for lenders and potential investors, as a positive cash flow is important for them to receive repayment of a loan or a return on their investment.

What are the limitations of net cash flow?

There are various limitations of net cash flow, which include:

• The cash flow figure alone does not show the profitability of a company, just the cash available in a specific period.
• Positive cash flow from a loan that needs repaying may not be positive for the business, and negative cash flow from an investment that could reap future rewards may not be negative. Therefore, care is needed to see the bigger picture.
• The net cash flow figure is historical and, thus, unable to be used to forecast future cash flows.
• This can make it difficult to assess a company’s liabilities accurately from this figure alone.
• Net cash flow should be taken as only one part of an overall picture when assessing the health of a business.

Net Cash Flow vs. Net Income: What is the Difference?

Net cash flow and net income are both important financial metrics but serve different purposes. Net cash flow measures the actual movement of cash in and out of a business over a given period, while net income represents the company's profitability based on accrual accounting principles.

A company can have a positive net income but still face cash flow issues due to differences in the timing of cash inflows and outflows. Therefore, it is essential for business owners to analyze both net cash flow and net income to get a comprehensive understanding of their company's financial health.