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+1-802-778-9005A cash flow statement is not very confusing in theory; it merely reflects how your money inflows and outflows in your enterprise. But for small entrepreneurs, it is hard to analyze how to calculate cash flow statements; it is not easy to compute cash flow formulas as it is dissimilar to working out the income and the expenses; it is much deeper than that.
For small scale entrepreneurs and business owners, cash flow is the essential element for running a business.
Let’s understand 3 major cash flow formulas: free cash flow formula, operating cash flow formula and cash flow forecast formula with examples.
Every person in business needs to understand cash flow statement formulas and its importance for their company’s growth. The cash flow formulas mentioned above make it more comfortable for a business owner to picture its financial inflows and outflows.
Free Cash Flow Formula (FCF) is the most general and vital cash flow formula.
This formula provides you a reflection of your company’s funds at a particular time. Still, it does not reflect the actual finances available to you, so it does not help plan the budget as it will not picture the Cash available to you.
Free Cash Flow helps recognize if you can afford certain things like; what software can you afford? Can you afford to get a digital assistant when your bills are due? How many gratitude cards can you manage?
You must be thinking that it is quite tough to calculate the free cash flow, but it is pretty straightforward in reality.
Firstly, you need to get accounting software to create your firm’s financial statements.
Let us discuss some accounting terms to calculate free cash flow formula:
Free Cash Flow = Net Income + Depreciation/ Amortization – Change In Working Capital – Capital Expenditure.
We can understand this better with a free cash flow formula example:
Chloe is a web developer; she has to compute her available cash flow to recognize if it is feasible to hire a digital assistant for about twelve hours a month.
Her finances seem like:
(Saira bought a new laptop last year)
So Saira’s cash flow is depicted by:
[$90,000] + [$100] – [$20,000] – [$1,500] = $68,600
Hence, $68,500 is Chloe’s available finance to reinvest back into her business.
Free cash flow formulas could be good at recording the available funds to re-establish the company. Still, it does not reveal your daily cash flow’s accurate reflection because FCF does not recognize irregular earnings, expenditures, or investments.
The better alternative for the FCF is the Operating Cash Flow Formula (OCF)
Like in the case of free cash flow, you will want your budget worked out; you can use operating cash flow for this.
There is one accounting term you will have to know:
Operating Income: The earning before interests, taxes, surplus, your operating profit deducted by using expenditures from the Total Income
Formula for operating cash flow = Operating Income + Depreciation – Taxes + Change in Working Capital
Applying the Operating Cash Flow formula to the preceding example:
[$95,000] + [$0] – [$8,000] + [-$11,000] = $76,000
Hence, in a particular year, Chloe generates a $ 76,100 cash inflow from her usual operating activities.
Free Cash Flow and Operating Cash Flow provide a complete picture of cash flow at a particular time, but the Cash Flow Forecast Formula gives a vision about the cash flow in the coming month.
It is an excellent practice as it allows you to determine what amount of cash flow you might have in the future.
It is very frustrating when you do not have enough funds planned out in the time of need, so it is better to forecast the available and needed funds.
Cash Flow Forecast is the most comfortably calculating formula among the FCF and OCF. There are no complex accounting terms jumbled up.
It is a straightforward computation of the money you anticipate to get in and paid out in the coming thirty to ninety days.
blueprint for the cash flow forecast:
Cash Flow Forecast = Beginning Cash + projected Inflows – projected outflows = Ending Cash
Beginning Cash is the money you have in hand on your current day.
Project inflow is the money you are supposed to get during a specific time phase.
Project outflow is the expenditures you are about to make in a specific time phase.
Let us use Chloe’s example again:
Her cash flow forecast seems like:
[$40,000] + [$40,000] – [$5,000] = $75,000
The cash flow forecast of Chloe’s finances in the coming 90 days would be $75,000.
This formula is the one which is regularly used by the business owners. This formula provides you the difference between the money that is coming out of your business for a particular period.
If you want to calculate the net cash flow, then you’re required to find the difference between the cash inflow and cash outflow. There are some ways through which you can calculate net cash flow, but let’s continue with the basics of the net cash flow formula:
Net cash flow = Cash receipts – Cash Payments
If you feel the need to go a step further, then you can separate cash flow by category: operating, financial, and investment
Let’s utilize the example of Ekta, who runs a small indie magazine. To find out about her net cash flow for the quarter, she’ll consider the following:
Cash flow from operating activities
Cash flow from investment activities
Cash flow from financial activities
To calculate the net cash flow, we’ll be using the following formula:
Net cash flow = ($13,000 – $8,000) + ($6,000 – $5,000) + ($3,000 – $1,000)
Net cash flow = $3,000 + $1,000 + $2,000
Net cash flow = $6,000
As a business owner, it is necessary to keep a record about where you and your finances are. It is not only important for the month ahead, but it helps you to get an idea about where you will be in the next quarter, the next year, or even the next decade!
The discounted cash flow formula tells you the expected value of a business which is based on the future cash flows.
The formula to calculate the discounted cash flow is:
Let’s break this down:
Let’s assume that you’re the owner of the food shop. You need to calculate your DCF to help you estimate the potential investments and find out if they’ll deliver a positive ROI.
Let’s assume you have $30,000 to invest, and you’re given the opportunity to invest into a company that is anticipated to pay dividends of $5,000 per year over the next 10 years. The discount rate here is 8%, because in this case, it’s the return that you will get if you invest in an index fund.
To calculate the future cash flow, you’re required to use the DCF formula:
DCF = (CF1 / (1 + r)^1) + (CF2 / (1 + r)^2) + … + (CFn / (1 + r)^n)
DCF = ($5,000 / (1 + 8%)^1) + ($5,000 / (1 + 8%)^2) + ($5,000 / (1 + 8%)^3) + ($5,000 / (1 + 8%^)4) + ($5,000 / (1 + 8%)^5) + ($5,000 / (1 + 8%)^6) + ($5,000 / (1 + 8%)^7) + ($5,000 / (1 + r)^8) + ($5,000 / (1 + 8%)^9) + ($5,000 / (1 + 8%)^10)
DCF = ($5,000 / (1.08)^1) + ($5,000 / (1.08)^2) + ($5,000 / (1.08)^3) + ($5,000 / (1.08)^4) + ($50,000 / (1.08)^5) + ($5,000 / (1.08)^6) + ($5,000 / (1.08)^7) + ($5,000 / (1.08)^8) + ($5,000 / (1.08)^9) + ($5,000 / (1.08)^10)
Then:
DCF = ($5,000 / 1.08) + ($5,000 / 1.1664) + ($5,000 /1.259712 + ($5,000 /1.36) + ($5,000 /1.47) + ($5,000 / 1.59) + ($5,000 /1.71) + ($5,000 /1.85) + ($5,000 /1.99) + ($5,000 /2.15)
Next step:
DCF = $4,629.63 +4,286.70 + $3969.16 + $3676.47 + $3401.36 + $3144.65 + $2923.98 + $2702.70 + $2512.56 + $2325.58
Lastly:
DCF = $33,576
In small business accounting terms, levered is explained as the business that is funded with borrowed capital, such as small business loans, investors, or any other external funding sources.
Keeping that in mind, the levered free cash flow is defined as how much capital your business has after you’ve accounted for all the payments to both short and long-term financial obligations. It’s the money that is accessible to investors, shareholders dividends, company management, and investments back into the business.
The formula for calculating levered free cash flow is mentioned below:
Let’s see what’s all these teams mean:
Let’s suppose you own and operate a landscaping company. When you began your company three years ago, you invested your own money $40,000 and borrowed $20,000. Every month, you owe a minimum of $1,000 on that debt.
In the first year, your EBITDA was around $160,000. This figure increases up to $185,000 in your second year and $300,000 in the third.
In the first year you also purchased all your machinery for $135,000, you also didn’t have any capital expenditure in the second year, and you spent $20,000 in the third.
The first working capital was $40,000, in year 2 it was $120,000, and $250,000 in Year 3. Look at the table mentioned below:
| Year 1 | Year 2 | Year 3 | |
| EBITDA | $160,000 | $125,000 | $200,000 |
| CAPEX | $135,000 | $0 | $20,000 |
| Working capital | $40,000 | $90,000 (100% change) | $125,000 |
| Mandatory debt payments | $12,000 | $1,200 | $1,200 |
Let’s get back to LFCF formula:
Let’s do the calculation for the first year:
LCFC = 160,000 – 40,000 – 135,000 – 12,000 = – $27,000
The second year:
LFCF = 125,000 – 90,000 – 0 – 12,000 = $23,000
The third year:
LFCF = 200,000 – 125,000 – 20,000 – 12,000 = $43,000
Unlevered free cash flow is known as the cash flow that a business has, without accounting for any interest payments. Basically it’s a business’s financial status which has no debts to pay, that means it’s a bit of an exaggerated number of what the business is actually worth.
This gives the more attractive numbers and the potential investors and lenders that levered cash flow calculation.
There is a very big difference between the levered free cash flow formula unlevered cash flow. The levered cash flow includes debts but the unlevered excludes them. This explains that the unlevered cash flow is higher than levered free cash flow.
The formula of unlevered free cash flow is mentioned below:
Unlevered free cash flow =
For the example, let’s get back to Year 1 and 2 of the landscaping business we have talked about above:
Remember, the time when you started your business three years ago, you invested $40,000 of your own money and purchased all the income and borrowed $20,000. In the second year, you didn’t buy any equipment, and your CAPEX was zero, still you had to pay debt.
But here we’re discussing UFCF, in this situation, so the debts aren’t part of the equation.
| Year 1 | Year 2 | |
| EBITDA | $160,000 | $125,000 |
| CAPEX | $135,000 | $0 |
| Working capital | $40,000 | $90,000 |
| Taxes | $25,000 | $40,000 |
Now that the numbers are available, let’s calculate for year 1:
UFCF = 160,000 – 135,000 – 40,000 – 25,000 = -$40,000
For the 2nd year:
UFCF = 185,000 – 0 – 90,000 – 40,000 = $55,000
If the UFCF is a negative figure, it doesn’t implicate something negative about your business. So, the first year required more CAPEX, such as equipment, but in this case, you recovered during the second year and generated a positive UFCF.
Before you begin calculating the change in Net Working Capital, you’re first required to find out your working capital:
The formula of calculating Net Working Capital is:
Net Working Capital = Current Assets – Current Liabilities
The formula to determine the change in the working capital on cash flow statement is as follows:
Net working capital for the current period – net working capital for the previous period = change in net working capital.
For example: Suppose a company named Raha Pvt Lmt has $805,000 and $890,000 in current assets for the year 2023 and 2024 respectively. And it has $700,000 and $650,000 in current liabilities for the respected year.
Now that both the number are available for the year 2023 and 2024, it easy to calculate the working capital:
| 2023 | 2024 | |
| Current assets | $805,000 | $890,000 |
| Current liabilities | $700,000 | $650,000 |
| Working capital | $105,000 | $240,000 |
Now, subtract the previous years working capital from the current year’s working capital on the basis of the calculations made above in the table:
$240,000 (2022) – $105,000 (2021) = $135,000.
The change in the Net Working Capital is $135,000.
It might look like a hardship to calculate all these cash flow formulas but facing a cash shortage is worse.
Keeping a record of your regular cash inflow and outflow lets you get a more comprehensive approach towards your financial statements.
With the help of these cash flow formulas, you can now solve the expected problems, and so you can also carry out your operations optimally and keep the cash flow issues in the past.
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