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What Is Cash Flow? - Definition, Calculation & Example

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  • 0:05 Definition of Cash Flow
  • 0:52 Formulas
  • 4:45 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
Companies can't function without sufficient cash flow. In this lesson, you'll learn what cash flow is and how to calculate it, and you'll be provided some examples. You'll also have a chance to take a short quiz.

Definition of Cash Flow

Cash flow is the money that comes in and goes out of a company. It is the generation of income and the payment of expenses. Cash inflows result from either the generation of revenue through the selling of goods and services, money borrowed, or money earned through investments.

If more cash is coming into the company than leaving the company, you are experiencing positive cash flow. But if more cash is leaving the company than coming into the company, then you are experiencing negative cash flow. Keep in mind that just because you are experiencing negative cash flow for the moment doesn't mean you are going to suffer a loss, because cash flow is dynamic. Cash flow is reported on the company's cash flow statement, which is also called a statement of cash receipts and disbursements.

Formulas

Accountants calculate cash flow in different ways for different purposes. In this lesson, we'll look at a few of the methods.

Free cash flow (FCF) measures how much cash you generate after taking into account capital expenditures for such things as buildings, equipment, and machinery. The formula is:

FCF = Operating Cash Flow - Capital Expenditures

You can usually find the information necessary to perform this calculation on your cash flow statement. Let's look at an example.

Let's say that your company earned $12,000,000 in revenue last year. When you add up all the capital expenses paid for your factory, equipment, and machinery, it totals $4,000,000. Now, let's figure out the FCF:

FCF = Operating Cash Flow - Capital Expenditures

FCF = $12,000,000 - $4,000,000

FCF = $8,000,000

You should note that if the number derived from the equation was negative, it means that you had negative cash flow. In other words, more money was spent on capital expenditures than was generated by operations.

Operating cash flow (OCF) is the measure of your company's ability to generate positive cash flow from its core business activities. Here's the formula:

OCF = Earnings before Interest and Taxes + Depreciation + Amortization - Taxes

Let's take a closer look at the equation. Earnings before interest and taxes (EBIT) is the revenue left over after subtracting the cost of production, selling, general expenses, and administrative expenses. It's a measure of your operating profit before interest and taxes are deducted. Depreciation is an accounting practice where you deduct the cost of a tangible capital asset, such as machinery or real estate, over a period of time, while amortization is where you deduct the cost of an intangible capital asset, such as a patent, over a period of time.

The information needed to perform the calculation can be found on your company's cash flow statement. Let's look at an example.

You company's EBIT is $150,000 this past year, and it took $10,000 in depreciation expenses and $7,500 in amortization. It paid taxes of $20,000. What is your company's operating cash flow?

OCF = EBIT + Depreciation + Amortization - Taxes

OCF = $150,000 + $10,000 + $7,500 - $20,000

OCF = $147,500

Net cash flow (NCF) is the difference between your company's inflows of cash and outflows of cash in a given period of time. Here's how you calculate it:

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