How to calculate cash flow: 7 cash flow formulas, calculations, and examples (2024)

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In theory, cash flow isn’t too complicated. Simply put, cash flow is a reflection of how money moves into and out of your business.

Unfortunately, for small business owners, both understanding and using cash flow formulas doesn’t always come naturally. In fact, 60% of small business owners say they don’t feel knowledgeable about accounting or finances.

But we can change that—starting here.

First, let’s talk about the importance of cash flow. For small businesses in particular, cash flow is one of the most critical ingredients in their financial health. One study showed that 30% of businesses fail because they run out of money.

Using cash flow formulas can help you prepare for slow seasons and ensure you have enough money on hand before spending on your business.

Here’s what we’ll cover in this article to help you calculate cash flow like a pro:

1. Important cash flow formulas, including:

2. Why calculating cash flow is important

Let’s jump in.

The following cash flow formulas each have their own benefits and tell you different things about your business.

Let’s go over definitions, calculations, and examples together. To make things extra easy, you can use our free cash flow calculator to follow along.

One of the most common and important cash flow formulas is free cash flow (FCF).

While a traditional cash flow statement (like the kind you can generate with Wave) gives you a picture of your business’s cash at a given time, that doesn’t always help with planning and budgeting—because it doesn’t truly reflect the cash you have available, or that’s free to use.While a traditional cash flow statement (like the kind you can get from Wave reports) gives you a picture of your business’s cash at a given time, that doesn’t always help with planning and budgeting—because it doesn’t truly reflect the cash you have available, or free to use.

Can you afford to invest in that new software? Do you have enough cash on hand to pay for that virtual assistant when their invoice comes due? How much money do you have available to spend on thank you cards for your clients?

Calculating the cash you have available to spend (via the FCF formula) helps answer those questions and others like them.‍

With that knowledge in hand, the basic formula for free cash flow looks like this:

Free cash flow = Net income + Depreciation/amortization – Change in working capital – Capital expenditure

Let’s take a look at an example of this formula in the real world. Randi’s a freelance graphic designer—she needs to calculate her free cash flow to see if hiring a virtual assistant for 10 hours a month is financially feasible.

Her financials for the year look like this:

So Randi’s free cash flow is represented by:

[$80,000] + [$0] – [-$10,000] – [$2,500] = $67,500

That means she has $67,500 in available cash to reinvest back into her business.

Net cash flow formula is one that’s regularly used by business owners.

This formula gives you the difference between the money coming in and the money coming out of your business for a specific period.

Here’s how it works:

The key about net cash flow is that it can fluctuate. For instance, investments or your operating costs may change over time. In the case of Shania and her magazine, she might decide to move from print to digital, drastically reducing operational costs. However, this shift might also reduce sponsorship, changing her cash flow in other areas.

With that in mind, remember to look at the context behind the numbers, not just the numbers themselves. This can give you a more realistic view of your net cash flow and the health of your business.

Knowing your cash flow from your operations is a must when getting an accurate overview of your cash flow.

While free cash flow gives you a good idea of the cash available to reinvest in the business, it doesn’t always show the most accurate picture of your normal, everyday cash flow. Here’s why: the FCF formula we mentioned above doesn’t account for irregular spending, earning, or investments. So, if you sell off a large asset, your free cash flow would go way up—but that doesn’t reflect typical cash flow for your business.

When you need a better idea of typical cash flow for your business, you want to use the operating cash flow (OCF) formula.

For example, if you’re looking to secure outside funding from a bank or venture capital firm, they’re more likely to be interested in your operating cash flow. The same goes if you begin working with an accountant or financial consultant, so it’s important to understand what OCF looks like for you before seeking funding.

Just as with our free cash flow calculation above, you’ll want to have your balance sheet and income statement at the ready, so you can pull the numbers involved in the operating cash flow formula.

There’s one other financial metric you’ll need to know for this calculation: Operating income.

Also called “earnings before interest and taxes” (or EBIT) and profit, your operating income subtracts operating expenses (like wages paid and cost of goods sold) from total revenue. You can find operating income on your income statement.

The basic OCF formula is:

[$85,000] + [$0] – [$9,000] + [-$10,000] = $66,000

That means, in a typical year, Randi generates $66,000 in positive cash flow from her typical operating activities.

Manage your business finances with Wave.

While both FCF and OCF give you a good idea of cash flow in a given period, that isn’t always what you need when it comes to planning for the future. That’s why forecasting your cash flow for the upcoming month or quarter is a good exercise to help you better understand how much cash you’ll have on hand in the future.

Because let’s be real. Cash flow problems are never fun, so it’s important to ensure positive cash flow before you start spending.

Your cash flow forecast is actually one of the easiest formulas to calculate. There aren’t any complex financial terms involved—it’s just a simple calculation of the cash you expect to bring in and spend over (typically) the next 30 or 90 days.

The formula looks like this:

As a business owner, keeping tabs on where you and your finances are at is a must. Not only is it important for the month ahead, but it helps you understand where you can be in the next quarter, the next year, or even the next decade!

But time (and the factors that come with it) change fast. So, how can you make an accurate prediction without a crystal ball? 🔮 Easy: the discounted cash flow (DCF) formula.

This formula tells you the expected value of a business based on future cash flows.

This type of formula could benefit from an example. So, let’s say you’re the owner of a coffee shop. You want to calculate your DCF to help you evaluate potential investments and determine if they’ll deliver a positive ROI.

Let's say you have $30,000 to invest, and you’re offered the opportunity to invest in a company which is expected to pay dividends of $5,000 per year over the next 10 years. The discount rate is 8%, because in this case, it's the return that you could get if you invested in an index fund.

To calculate future cash flows, you’ll use the DCF formula:

DCF = (CF1 / (1 + r)^1) + (CF2 / (1 + r)^2) + … + (CFn / (1 + r)^n)

Now let’s plug and play:

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)

This becomes:

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)

And 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

And finally:

DCF = $33,576

You did it!

With a DCF of $33,576, the discounted cash flow is worth more than the initial investment of $30,000 in today's dollars. Well done! 👏

Before we jump into this formula, let’s break out the dictionary.

In terms of small business accounting, “levered” means the business was funded with borrowed capital, like small business loans, investors, or other external funding sources.

With that in mind, your levered free cash flow is how much capital your business has after you’ve accounted for all payments to both short- and long-term financial obligations. It’s the money available to investors, company management, shareholder dividends, and investments back into the business.

Pretend you own and operate a landscaping company. When you started your company three years ago, you put forward $50,000 of your own money down and borrowed an additional $20,000. Each month, you owe a minimum of $1,000 on that debt.

In the first year, your EBITDA was $150,000. That figure grew to $175,000 in your second year and $200,000 in the third.

Year 1 was also when you purchased all of your machinery for $125,000, you didn’t have any capital expenditures in the second year, and you spent $20,000 in the third.

Year 1’s working capital was $50,000, $100,000 in Year 2, and $250,000 in Year 3. Here’s what this all looks like:

Unlevered free cash flow is the cash flow a business has, without accounting for any interest payments. Essentially, it’s a business's financial status if they had no debts to pay, which means it’s bit of an exaggerated number of what your business is actually worth.

That said, it can provide a more attractive number to potential investors and lenders than your levered free cash flow calculation.

Because companies fund differently, UFCF is a way to provide a more direct comparison in cash flows for different businesses, especially when evaluating them against one another. Likewise, each business could have a different payment structure and interest rate with their debtors, so UFCF creates a level playing field for comparative analysis.

There’s one major difference between the levered free cash flow formula we reviewed above to the unlevered one: levered free cash flow includes debts, and unlevered excludes them. This means that the unlevered free cash flow is higher than levered free cash flow.

The formula for UFCF is as follows:

For this example, let’s go back to Year 1 and 2 of the landscaping business we mentioned above.

Remember, when you started your company three years ago, you put $50,000 of your own money down, purchased all of your equipment, and borrowed an additional $20,000. In the second year, you weren’t buying more equipment, so your CAPEX was zero, however, you still had debt to pay.

But because we’re talking about UFCF, in this scenario, your debts aren’t part of the equation.

Here are the numbers.

No matter the size of your business, calculating cash flow is an important step to running your business, and, to put it simply: not run out of cash.

“It is absolutely critical that any entrepreneur understand what their business working capital needs are and plan ahead to ensure their ability to finance growth,” Colin Darretta, Co-founder & CEO of Innovation Department, told Forbes. “There are more financing tools than ever before, meaning for those who understand and are prepared, it need not be the catastrophic cash crunch it often is for early-stage businesses.”

And as you can see from the seven formulas above, it’s so much more than keeping track of what’s coming in and out of your business. Knowing your present, future and predicted cash flows are all ways to understand your business’s financial health and plan for what’s to come. The more you know about the problems that might pop up (which always-organized-accounting helps you see), the better you can solve them and solve them before they hit.

No crystal ball required.

By Rachelle Waterman