What is Net Cash Flow?

Net cash flow is the amount of cash generated or lost over a specific period of time, usually over one or more reporting periods. This concept is used to discern the short-term financial viability of a business, which is considered to be its ability to generate cash. If a company is consistently generating positive net cash flow over a long period of time, this is the best indicator of its viability. Conversely, continuing negative net cash flow is the prime indicator of any number of operational or financing problems (though it could also mean that a business is growing rapidly and so requires more working capital than usual). Net cash flow is comprised of three forms of activities, which are noted below.

Cash Flows from Operating Activities

This is cash both generated and used by the basic operations of a business, such as cash receipts from customers and expenditures for cost of goods sold and administrative expenses. A business needs to have positive cash flows from its operating activities over the long term, or else it will eventually run out of cash. A startup business or one that is growing rapidly will frequently experience negative cash flows; this is because they need to finance rapidly-expanding amounts of accounts receivable and inventory.

Cash Flows from Financing Activities

This is cash received through a debt agreement, or cash issued to pay off a debt, repurchase company shares, or pay out a dividend. If a business is not generating much positive cash flow from its operating activities, then it will need to obtain cash from its financing activities to keep operations running.

Cash Flows from Investment Activities

This can be cash received from a gain on an investment, or cash issued to buy an investment instrument or purchase fixed assets. An asset-heavy business, such as one that requires large amounts of infrastructure, will likely invest significant cash in this category.

Related AccountingTools Courses

The Interpretation of Financial Statements

The Statement of Cash Flows

Net Cash Flow Formula

Net cash flow can be derived through either of the methods noted below:

Cash receipts minus cash payments. This appears at first to be the most direct method of deriving net cash flow, but the accounting transaction recording system does not usually aggregate or report information in this manner. Consequently, the next method is used by most organizations.
Net profits plus non-cash expenses. This approach begins with the net profit or loss figure at the bottom of the income statement and then adds back all non-cash expenses, which typically include depreciation, amortization, and depletion.

Net Cash Flow Reporting

A summary of the cash flows of a business is formalized within the statement of cash flows, which is a required part of the financial statements under both the GAAP and IFRS accounting frameworks. This report is not usually included in the financial statement package distributed within a business for internal consumption, but is included in the reporting package that is issued to the investment community. A sample statement of cash flows appears in the following exhibit.

How to Use Net Cash Flow

Net cash flow is closely tracked by the treasurer, who needs this information to predict the cash needs of a business, which he or she uses to either plan for investments having different maturity dates, or for the acquisition of additional debt to fund operations.

You cannot use net cash flow as the sole determinant of financial viability. You should measure net cash flow in conjunction with any changes in the level of debt (since additional borrowing also increases cash flows), the sale of any fixed assets (which can generate cash), and changes in the ongoing maintenance of the business (such as for equipment maintenance, employee training, and research and development). These additional items indicate that, despite apparently strong net cash flow, a company's overall competitive position has actually declined.

Net Cash Flow vs. Net Profit

Net cash flow is not the same as the net profit or net loss reported by a business, since these measures (for a business reporting under the accrual basis of accounting) include a variety of accruals for both revenue and expenses that do not indicate the actual flow of cash. Consequently, it is quite likely that the net profit reported by a business will differ substantially from its reported net cash flow figure.