# How to Calculate Cash Flow?

##### Yarab A|Updated on: January 28, 2022

Cash flow is the lifeblood of business. The way you manage the cash flow will define the success of your business. If managed well, it will help you to create more cash cushion that is essential for business growth. On the other hand, if not managed efficiently, it will be the major reason for the failure of business due to insufficient funds.

To define cash flow, it is a statement that summarizes the change in the cash position i.e. inflow and outflow of cash and cash equivalents. Read Cash Flow: What is Cash Flow Statement Definition and Example to know more.

If your cash inflow is more than the outflow, it is positive cash flow.  If the cash outflow is more than the inflow, it is called negative cash flow and indicates that the business will run out cash on a longer run.

To know and measure whether the cash flow has positively impacted the business, you need to calculate the cash flow. There are different formulas and method to calculate cash flows as detailed in the next section.

## How to calculate cash flow

To calculate cash flow, you can either apply the direct method or the indirect method. Each method uses different formulas to calculate cash flow.

### Direct method of cash flow calculation

Under the direct method of cash flow, the gross cash outflow and inflow of business operations are considered to arrive the net cash flow. The cash inflow i.e. cash receipts from sales, accounts receivables etc. are reduced with the cash outflow made towards various expenses like rent, salary, accounts payables etc.  The remaining balance is the net cash flow.

Here, all non-cash aspects like depreciation, bad debts etc. are not included.

Let us understand how to calculate cash flow using the direct method with an example.

 Calculating cash flow using the direct method Cash inflow Receipts from customers 9,00,000 Cash sales 1,00,000 Interest received 25,000 Total cash inflow 10,25,000 Cash outflow Payment to vendors 6,00,000 Salaries and wages 75,000 Office expenses 15,000 Tax paid 15,000 Total cash outflow 7,05,000 Net cash flow (10,25,000 – 7,05,000) 3,20,000

### Indirect method of cash flow calculation

To calculate cash flow using an indirect method, the net income is adjusted with all non-cash-items.  Here, an increase in the asset is reduced from net income and an increase in liability is added back to net income.

Under this method, the cash flow is divided into three sections – operating, investing, and financing activity. For each section, the net cash flow is arrived after making the suitable adjustments

Let’s understand how to calculate cash flow using the indirect method

 Calculating Cash flow using the indirect method Cash flow from operating activities Net Income 20,00,000 Add: Non-cash adjustments debited to P&L a/c Depreciation 1,00,000 Amortisation 50,000 Bad debts 20,000 1,70,000 Less: Non-cash adjustments credited to P&L a/c Profit on sale of fixed assets 60,000 Increase in accounts receivables 2,00,000 Decrease in accounts payables 50,000 3,10,000 Cash from operating activities 18,60,000 Cash flow from investing activities Sales of fixed assets 50,000 Less: Purchase of fixed assets (land, building, furniture, machinery) 8,00,000 Net cash from operating activities (50,000 – 8,00,000) (7,50,000) Cash flow from financing activities Issue of equity and preference share capital (cash only) 4,00,000 Less: Payment of dividend 70,000 Net Cash from financing activities (4,00,000 – 70,000) 3,70,000 Net increase in cash and cash equivalents (The net cash flow from the first three activities) 14,80,000 Cash and cash equivalents and the beginning of the period 2,00,000 Cash and cash equivalents and the end of the period (net cash flow + cash at the beginning of the period) 16,80,000

## Rules for calculating cash flow using the indirect method

 Add or Reduce from Net income Details Add Decrease in non-cash current assets Reduce Increase in non-cash current asset Add Increase in current liabilities Reduce Decrease in current liabilities Add Non-cash adjustments (Depreciation and/or amortization Subtract Non-cash revenues Add Non-operating losses Reduce Non-operating gains

Preparing cash flow statements helps businesses to know the net cash position and enables business owners to make smart decisions. Also, one can investigate the areas that require attention and accordingly optimize the cash position. Read 6 Tips for Efficient Cash Flow Management to know what all you can do to optimize the cash flow.

Cash flow statement being a key report, using accounting software helps you to get these reports instantly over and above helping you to manage your business more efficiently.

Today, accounting software is provisioned to generate the cash flow projection report that indicates a projected cash flow position considering the anticipated revenues and outflow. This helps you make a better business decision.

Read more on Cash and Credit Management

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