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

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:

• Free cash flow

• Net cash flow

• Operating cash flow

• Cash flow forecast

• Discounted cash flow

• Levered free cash flow

• Unlevered free cash flow‍
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   2. Why calculating cash flow is important

Let’s jump in.

Important cash flow formulas to know about

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.

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

• Net cash flow = Net cash flow = Cash receipts - Cash payments
  

• Operating cash flow = Operating income + Depreciation – Taxes + Change in working capital

• ‍Cash flow forecast =  Beginning cash + Projected inflows – Projected outflows = Ending cash
  

• Discounted cash flow = [(cash flow 1) ÷ (1 + r)^1] + [(cash flow 2) ÷ (1 + r)^2] + [(cash flow n) + (1 + r)^n]
  

• Levered free cash flow = Earned income before interest, taxes, depreciation/amortization – Change in net working capital – Capital expenditures – Mandatory debt payments

• ‍Unlevered free cash flow = Earnings before interest, tax, depreciation, and amortization – Capital expenditures – Working capital – Taxes
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1. Free cash flow formula

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.‍

How to calculate free cash flow

Calculating your business’s free cash flow is actually easier than you might think. To start, you’ll need your company income statement or balance sheet to pull key financial numbers.

First, let’s get some important financial terms straight.

• Net income: The total income left over after you’ve deduced your business expenses from total revenue or sales. You’ll find this on your income statement.

• Depreciation/amortization: Many of your business assets (like equipment) lose value over time. Depreciation is the measurement of how that value decreases. Amortization, on the other hand, is a method of breaking down the initial cost of an asset over its lifetime. You’ll find depreciation and amortization on your income statement.

• Working capital: Working capital is the difference between your assets and liabilities and represents the capital used in the day-to-day operation of your business. You can calculate your working capital using the total assets and liabilities on your balance sheet.

• Capital expenditure: Capital expenditures include money your business spends on fixed assets, like land, real estate, or equipment. You can find your capital expenditure on the statement of cash flows.
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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

Who is this formula best suited for?

The free cash flow formula is suited for any business owner who wants to get the most accurate look at their financial health. And this could be for many reasons. For example:

• You’re looking for investors: People invest to make money. If an investor were to back a business that can’t turn a profit, that investment isn’t likely to deliver a strong return on investment (ROI).

• ‍You need a loan: Much like investors want ROI, lenders want their money back—plus the interest owed. Without profitability, businesses have a harder time paying back loans.

• You’re looking to get a line of credit: If you’re opening a line of credit for your business, creditors will also look at your FCF metrics to determine the legitimacy of your company and ability to pay your debts.

• You want a business partner: If you’re looking to attract a business partner to help you grow, they’ll want to see a healthy FCF to determine the viability of the venture.

What does the free cash flow formula tell you?

Free cash flow formula tells you the difference between cash generated from standard business operations and cash spent on assets. Ultimately, it indicates your business’s financial performance and health, and ability to stay in business.

Free cash flow example

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:

• Net income = $80,000
• Depreciation/amortization = $0
• Change in working capital = – $10,000
• Capital expenditure = $2,500

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.

2. Net cash flow formula

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:

• Making money? Your net cash flow will be positive.

• Losing money? Your net cash flow will be in the negatives.
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Easy, right? Now let’s review the business activities that net cash flow comes from.

• Operating: Cash generated and spent by a company to be able to run standard business operations. This includes cash payments from customers, cost of goods sold, administrative expenses, and marketing.

• Financing: Financing cash outflow and inflow includes debt and dividend payments, company shares, and small business loans, among others.

• Investment: This includes when businesses earn or pay interest on investments or purchase a business investment like equipment or property.

How to calculate net cash flow

To calculate net cash flow, you’ll have to find the difference between the cash inflow and the cash outflow. There are a few ways to calculate net cash flow, but let’s start with the basics of the net cash flow formula:

Net cash flow = Cash receipts - Cash payments

If you want to go a step further, you can separate cash flow by category: operating, financial, and investment..

Net cash flow example

Let’s use the example of Shania, who runs a small-but-mighty indie magazine. To find out her net cash flow for the quarter, she’ll look at the following:

Cash flow from operating activities

• $12,000 came in
• $9,000 went out
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Cash flow from investment activities

• $500 came in 
• $2,000 went out
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Cash flow from financial activities‍

• $4,000 came in
• $2,000 went out
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To calculate net cash flow, we’ll use the following math:

Net cash flow = ($12,000 - $9,000) + ($500 - $2,000) + ($4,000 - $2,000)

Net cash flow = $3,000 + -$1,500 + $2,000

Net cash flow = $3,500

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.

3. Operating cash flow formula

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.

How to calculate operating cash flow

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:

Operating cash flow = Operating income + Depreciation – Taxes + Change in working capital

Operating cash flow example

To apply the cash flow from operations formula to our previous example (Randi, our favorite freelance graphic designer), let’s say her financials for the year look like this:

• Operating income = $85,000
• Depreciation = $0
• Taxes = $9,000
• Change in working capital = – $10,000
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Randi’s operating cash flow formula is represented by:

[$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.

4. Cash flow forecast formula

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.

How to calculate operating cash flow

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:

Cash flow forecast = Beginning cash + Projected inflows – Projected outflows = Ending cash

• Beginning cash is, of course, how much cash your business has on hand today—and you can pull that number right off your statement of cash flows.

• Project inflows are the cash you expect to receive during the given time period. That includes current invoices that will come due and future invoices you expect to send and receive payment for.

• Project outflows are the expenses and other payments you’ll make in the given timeframe.
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Cash flow forecast example

Let’s get back to good ol’ Randi. Let’s say she has:

• Beginning cash = $30,000
• Projected inflows for the next 90 days = $30,000
• Project outflows for the next 90 days = $4,000
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Here’s what her cash flow forecast looks like:

[$30,000] + [$30,000] – [$4,000] = $56,000

That means Randi’s forecasted cash flow for the upcoming quarter is $56,000.

5. Discounted cash flow formula

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.

How to calculate discounted cash flow

Prepare yourself: the following formula looks very Matt-Damon-in-Good-Will-Hunting. But trust us on this—it’s not that scary! Here’s a step-by-step breakdown of how to calculate discounted cash flow:

DCF = [(cash flow 1) ÷ (1 + r)^1] + [(cash flow 2) ÷ (1 + r)^2] + [(cash flow n) + (1 + r)^n]

Let’s break this down.

• Cash flow: Cash flow for the given year. Cash flow refers to the money moving in and out of your business. But we will focus on the net cash flow which is the net of inflows and outflows.

• ‍Cash flow 1: Cash flow for the first year.

• Cash flow 2: Cash flow for the second year.

• Cash flow n: The period number. Time periods can be years, quarters, months, etc.

• r: The discount rate. The discount rate is used to find the present value of future cash flows. You’ll have to do some research to determine the appropriate discount rate for your calculation—it shouldn’t be lower than the inflation rate.

Discounted cash flow example

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! 👏

6. Levered free cash flow formula

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.

How to calculate levered free cash flow

The formula for calculating levered free cash flow goes like this:

Levered free cash flow =
Earned income before interest, taxes, depreciation and amortization - Change in net working capital - Capital expenditures - Mandatory debt payments

Back to the dictionary. Let’s review what each of these terms mean:

• Earnings before interest, taxes, depreciation, and amortization: Also known as EBITDA, this is an alternative to simple earnings or net income that you can use to determine overall financial performance.

• Capital expenditures: Also referred to as CAPEX, these are investments in property, buildings, machines, equipment, and inventory, as well as accounts payable and accounts receivable.

• Working capital: This is the total working capital that business has available

• Mandatory debt payments: This is what a business owes to debtors, like lenders, investors, interest, etc.

Levered free cash flow example

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:

Let’s go back to our LFCF formula:

LFCF = EBITDA - Change in net working capital - CAPEX - Mandatory debt payments

Now we’ll do the calculation for the first year: 

LCFC = 150,000 - 50,000 - 125,000 - 12,000 = - $37,000


And the second year: 

LFCF = 175,000 - 100,000 - 0 - 12,000 = $63,000

And the third year: 

LFCF = 200,000 - 125,000 - 20,000 - 12,000 = $43,000


Congrats! These are representative of a healthy, financially thriving and sustainable landscaping business that keeps on mowing and growing! Or maybe the other way around.

7. Unlevered free cash flow formula

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.

How to calculate unlevered free cash flow

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:

Unlevered free cash flow =
Earnings before interest, tax, depreciation, and amortization — Capital expenditures — Working capital — Taxes

Unlevered free cash flow example

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.

Now that we have these numbers, let’s bring them into the equating for Year 1:

UFCF = 150,000 — 125,000 — 50,000 — 25,000 = —$50,000

And Year 2 looks like this:

UFCF = 175,000 — 0 — 100,000 — 40,000 = $35,000

Even if the UFCF is a negative figure, it’s not necessarily a negative implication about your business. Predictably, the first year required more CAPEX, like equipment, but in this case, you were able to recuperate during the second year and generate a positive UFCF. Congrats!

Why calculating cash flow is important

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.