Net cash flow : Definition & Formula

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Net cash flow of a company

Net cash flow is a key indicator for assessing the accounting and financial health of a business. It represents the amounts immediately available to the company, and should therefore be closely monitored. So, what is the definition of net cash flow? How is it calculated? And, above all, how should it be analysed and used? In this article, our experts focus on the question and provide their answers.

Net Cash Flow Defined

The net cash flow of a business corresponds to the sums of money it can use in the short term: this is also known as sight balance. The “short term” notion is not specifically defined and will depend on each company and its business activity, organisation and context. Put simply, net cash flow means the cash available to the company as soon as it needs it.

Net cash flow is particularly used to analyse the financial equilibrium of the company, in an audit for instance.

Net Cash Flow and Statement of Sources and Uses of Funds

Net cash flow is an item taken into account in the statement of sources and uses of funds. This statement is drawn up based on the company’s balance sheet: it organises the items according to their degree of liquidity. Therefore, this statement distinguishes between the company’s investments, operations and cash flow. And net cash flow is in this latter part.

Below is a template of this statement that you can download and complete:

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Net Cash Flow Items: WCR and working capital

Net cash flow is based on two key concepts: the working capital requirement (WCR)and working capital (WC), that can be found in the company’s balance sheet. Net cash flow results from the difference between the working capital and the WCR.

Working Capital Requirement (WCR)

The WCR is the money that the business must allow to cover the financial needs of its activity. It is a key concept in accounting because of the time-lags between cash coming in and going out of a business. A receivable is not necessarily paid immediately by a customer, an item may remain in stock for several weeks before it is sold, etc. The WCR corresponds to the sums that the business must have to make up for these delays and continue operating (paying suppliers, employees, mandatory contributions, etc.).

To learn more: Everything you need to know about Working Capital Requirement (WCR): method, calculation, analysis

Working Capital (WC)

Working capital, or net working capital (NWC), therefore corresponds to the money that the business has in reserve in the short and medium term and can use to cover the expenses that make up the WCR (suppliers, staff, contributions, etc.) and any unexpected events (health crisis for example).

To learn more: Working Capital Everything you need to know!

Why Calculate Net Cash Flow?

Calculating the net cash flow of a business is vital for its leaders, whether it is just starting out or is already well established. Beyond its calculation, this indicator should also be monitored over time using cash management software.

Net Cash Flow of a Start-Up

If the company is just starting up or being taken over, calculating the net cash flow allows the directors to ensure that it will have sufficient cash flow to give the business time to start making a profit. The directors will be able to plan the appropriate financing accordingly. This step is found in the financial part of the business plan, which includes:

● a cash flow statement that calculates the company’s monthly cash flow forecast, over 12 to 18 months.

● a cash flow plan which plans the financing of the operating cycle and strategy of the business, based on the needs identified in the cash flow statement.

By calculating and monitoring net cash flow, it is therefore possible to check that the project is viable when it is launched, estimate the money needed and ensure that the business will eventually be self-sufficient.

Net Cash Flow of an established Business

By calculating and monitoring its net cash flow daily, the company can:

● take action in response to any financial, economic or commercial difficulties (investments, change of strategy, etc.);

● make decisions independently by having its own visibility of future payment dates;

● be more confident on a daily basis.

Although net cash flow monitoring is often presented in the company’s monthly dashboard, many business people track it each week to be able to react fast.

Net cash flow should also be part of the budget procedure so as to anticipate the financing needed to grow the business.

Also read: Setting up cash flow forecast

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How to calculate a company’s net cash flow

Although the ultimate aim of calculating the net cash flow is to know the amount of cash available, it is not done by adding up the company’s different bank balances. A simple "sum" would not take into account the significant changes relating to wages, contributions and taxes.

In practice, net cash flow corresponds to a remainder: it is therefore more accurate to do a subtraction. There are two ways to calculate a company's net cash flow:

- based on the upper part of the balance sheet;

- or based on the lower part of the balance sheet.

Calculating Net Cash Flow on the Upper Part of the Balance Sheet: WCR and Working Capital

The upper part of a balance sheet sets out the funds brought in by investors (capital, long-term borrowings, etc.) and used to obtain fixed assets (buildings, equipment, etc.). The difference between these assets (fixed assets) and these liabilities (investors’ equity) forms the working capital (WC).

This calculation method therefore takes the working capital (WC) and working capital requirement (WCR) into account.

Net cash flow = WC - WCR

Calculating Net Cash Flow on the Lower Part of the Balance Sheet: liquid assets and financial debts

The lower part of the balance sheet includes the company’s running costs (raw materials, wages, etc.), that will only be covered once its customers pay their invoices. These variations often constitute financial debts (overdrafts, invoices outstanding, etc.). When faced with these debts, the company can count on its liquid assets (cash in bank, investments, bank loans, etc.).)

The calculation method by the lower part of the balance sheet therefore takes account of the company's liquid assets and its financial liabilities:

Net cash flow = liquid assets - financial debts

Example of Net Cash Flow Calculation

The same result is obtained with the two calculations above. Here is a practical application of these two methods based on a company "X"

Balance Sheet of Company X

AssetsLiabilities
Fixed assets £3,000Equity £2,300
Inventories £800Financial debts £1,800
Trade receivables £1,000Trade payables £1,200
Cash in hand £1,500Bank overdrafts £1,000
Total £6,300Total £6,300

Calculating the net cash flow of Company X on the upper part of the balance sheet: Net cash flow = working capital - WCR Net cash flow = (equity + financial liabilities - fixed assets) - (inventories + trade receivables - trade payables) Net cash flow = (2,300+1,800-3,000) - (800+1,000-1,200) Net cash flow = (1,100-600) Net cash flow = £500

Calculating the net cash flow of Company X on the lower part of the balance sheet: Net cash flow = cash in hand - short term financial debt Net cash flow = 1,500 - 1,000 Net cash flow = £500

Analysing the Net Cash Flow of a Business

Once you have calculated the net cash flow, three situations are possible:

● net cash flow is positive;

● net cash flow is zero;

● net cash flow is negative.

Positive Net Cash Flow

Positive net cash flow (above 0) is generally a sign of financial soundness and good management: the company’s revenues cover all of its needs without recourse to external financing. The company can therefore use these resources for other short-term needs.

However, the interpretation will depend on the context: positive net cash flow may result from some specific data such as the sale of a substantial part of the production facilities, or a gap in investments. These situations can then adversely affect the business at a later date.

Zero Net Cash Flow

If net cash flow is zero (equal to 0), this means that the company’s resources only just cover its needs. This is a tricky situation, as any change in the working capital or WCR could lead to a negative cash position.

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Negative Net Cash Flow

Negative net cash flow (below 0) means that the working capital is not sufficient to cover the WCR, resulting in a bank overdraft, and therefore a need for capital. This need can be met in different ways:

● by short-term

● by consolidation loans;

● by an unusual increase in trade payables (which should be avoided).

This situation must only be temporary: if these difficulties become structural, the company could face the risk of bankruptcy.

How to improve your net cash flow

First step: identify the causes of the problem

A shortage of working capital to cover the WCR is very often easy to explain. If the WCR increases but the working capital does not, the situation may be due to:

ill-managed growth: the WCR increases much faster than the working capital.

an insufficient volume of finished product sales: the sudden rise in the WCR, due to an increase in finished product stocks, is not matched by the working capital, which remains flat or only increases slowly.

This difference between the WCR and working capital may also be due to a decrease in working capital, possibly as a result of:

medium- and long-term loans (MLT) that do not provide sufficient financing for investments;

higher expenditures;

● an increase in repayments on medium- and long-term loans.

Once the problems identified, two complementary courses of action are possible and can be taken in combination: improving the working capital, and reducing the WCR.

Improving Working Capital (WC)

To improve the WC, new sources of income must be found, to bring in more liquid assets. This can be achieved with:

● a more profitable business (price increase, new strategy, etc.);

● an increase in long-term resources (long-term loan, capital increase, etc.);

● a reduction in long-term fixed assets (property sale, disposal of idle production facilities, etc.).

Reducing the Working Capital Requirement (WCR)

Reducing the working capital requirement lowers the amounts of money the company spends on its operations. This can be achieved in different ways. Here are some examples:

better WCR management with better structured and more efficient cash flows: shorter customer payment terms, or longer supplier payment terms, etc.;

● a reduction in stocks;

● a reduction in the cost of products, possibly combined with an increase in supplier payment terms;

production based on order intake to limit stocks of finished or semi-finished products.

Which software do you need to improve your net cash flow forecasts?

Cash management is a basic factor in running a business, however big or small. If it is done in an old-fashioned way, it can be very time-consuming, and generate stress for the manager who does not have enough visibility to run the business with complete peace of mind. Yet, monitoring and anticipating a company’s cash flow can be made easy with cash management software like Agicap. Designed specifically to automate the process and save time, Agicap allows you to manage your company based on its cash flow.

Agicap provides very small businesses and SMEs with bespoke cash monitoring functions that adapt to their organisation:

- cash flow forecasts; - cash flow monitoring; - reports; - integration with other tools (billing, pay, etc.); - consolidated view of a group’s accounts, etc.

Although it seems easy to calculate, a company’s net cash flow is nonetheless an essential indicator of its good financial health. It is therefore in the interest of directors to monitor it closely in order to make the right decisions and anticipate the future of their company.

**Keen to know how Agicap can help with your cash flow challenges?


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