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Managing Corporate Cash Flow: Calculating Cash Flow and Understanding Its Sources

By: iTHINK Financial | May 22, 2020

There are certain metrics every business owner should be closely familiar with—corporate cash flow is near the top of that list. Calculating and understanding your corporate cash flow can give you a clearer idea of the health of your business, not to mention it is one of the first things lenders or potential investors look at when considering working with your business.

Whether you have a team of accountants handling business finances, or are a small business trying to make sense of the numbers on your own, use this article as your guide to understanding what corporate cash flow is, getting to know its sources, calculating your cash flow, and analyzing where your business stands. 

What is Corporate Cash Flow?

Just as its name suggests, corporate cash flow refers to the money coming in and out of your business. In this usage, the term ‘cash’ relates to not only physical money but also balances in checking accounts, checks, or any other sums that can be quickly liquidated into physical cash. 

Maintaining a positive cash flow shows your business is building cash reserves, which means it is better able to reinvest money into growth strategies, pay employees and shareholders, and show lenders you will be able to make payments on loans when applying for financing. In other words, looking at your business’s cash flow is essential in assessing a company’s overall financial health.   

The Three Sources of Corporate Cash Flow

Before diving into cash flow calculations, it’s important to first understand where that cash is coming from. In business, cash flow comes from three main sources: operating, investing and financing. Here’s a quick breakdown of each cash flow source.

Cash from Business Operations

Operating cash flow includes funds generated by a company’s main business activities. It is calculated by subtracting wages, purchases, rent payments and other business expenses related directly to business operations from sales revenue, accounts receivable, interest earned or other operational positive cash flows. At its core, your net operating cash flow shows how much your business earned or lost from its basic business functions. But this number also tells a much deeper story, including highlighting areas where you may be overspending or under performing.

Cash from Business Investments

The money you have either made or spent on long-term business investments makes up your business’s total cash flow from investment activities. Long-term investments include commercial property, buildings, equipment and vehicles, otherwise known as fixed assets. If your business purchased a new vehicle, sold a property or paid for maintenance on equipment—the latter is considered a capital expenditure—those transactions would be accounted for in this measure of corporate cash flow.

Cash from Business Financing

For the majority of businesses, cash flow from financing activities is made up of funded loans (inflow) and payments on debt (outflow). Financing can also refer to raising capital for your business—money received from investors—or dividends paid to shareholders. Your business’s net cash flow from financing activities lets lenders and potential investors know if your business has the means to make payments on any future debt. 

How to Run a Cash Flow Statement

With a better idea of what goes into calculating business cash flow, it’s time to put theory into practice. Running a cash flow statement is the most common way of calculating business cash flow. It includes operating cash flow, cash flow from investment activities and cash flow from business financing, as well as a total net cash flow showing an increase or decrease. 

There are a number of ways to run a cash flow statement. Accounting-savvy business owners armed with a complete record of business finances can create cash flow statements using an Excel spreadsheet. However, many business accounting programs will do the heavy lifting for you as long as your income and expenses are clearly categorized, accurate and up to date.  

Analyzing Your Business’s Cash Flow

Once you have a completed cash flow statement, the next step is to make sense of the figures before you. These unassuming numbers on a spreadsheet can hold a glimpse at your company’s present financial situation and can even be a way to forecast the future. To analyze your business’s standing or get a better idea of how business analysts, creditors and potential investors may view your company’s finances, you will want to consider your debt-service coverage ratio and free cash flow.

Debt-Service Coverage Ratio

In corporate finance, demonstrating a business’s ability to pay short-term liabilities—including commercial loans and lines of credit—is essential to win the favor of lenders and investors. When considering opening a new loan or investing in a business, analysts look at a company’s debt-service coverage ratio to determine if that business can handle its current liabilities with the income it is generating. The calculation is simple—subtract short-term obligations from net operating income. 

If the result is less than 1, this indicates a negative cash flow. A ratio above 1 means a business is able to cover current debt obligations. However, if that ratio is very close to 1, say 1.1, some lenders may be hesitant to offer additional financing as a slight downturn would mean the business may be unable to make payments.

Free Cash Flow

Free cash flow is a calculation of the cash balance readily available for business use—it is often considered the most accurate representation of a business’s profitability and financial health. This figure is calculated by subtracting capital expenditures from operating cash flow. The resulting number demonstrates the amount of money a company has to grow operations, pay shareholders dividends or pay off debt, making it a particularly telling figure for potential investors and lenders. 

Growing free cash flow is often a precursor to an uptick in profits, making a company with consistently rising free cash flow a sound investment. On the other hand, if free cash flow is decreasing, it shows a company may be unable to survive or not do so without taking on additional debt.

Taking the Next Steps

Having a clear, complete and accurate understanding of your business’s cash flow gives business owners the tools needed to plan for what’s next. Whether you have determined it’s time to cut back on operating expenses to increase net income, or are seeing a positive cash flow and considering a commercial loan to expand operations and grow faster, this knowledge helps you take control of your business finances.

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