How to Calculate Cash Flow
Understand the three types of cash flow, how to calculate operating, investing, and financing cash flows, and how to use the indirect method to build a cash flow statement.
Why Cash Flow Is Not the Same as Profit
A company can be profitable on paper — recording positive net income — and still run out of cash. This happens because accrual accounting recognizes revenue when earned and expenses when incurred, regardless of when cash changes hands. A business that invoices $500,000 in December but does not collect until February shows the profit in December but the cash in February. Cash flow measures actual money in and out of the business, making it the more reliable indicator of short-term solvency.
The Three Types of Cash Flow
The Statement of Cash Flows is divided into three sections. Operating cash flow (OCF) comes from core business operations — collecting from customers and paying suppliers, employees, and overhead. Investing cash flow reflects purchases and sales of long-term assets like equipment, property, or securities. Financing cash flow covers debt issuance and repayment, equity raises, and dividend payments. Healthy businesses generate positive OCF and use it to fund investing activities, while financing activities are episodic.
Calculating Operating Cash Flow: Indirect Method
Most companies use the indirect method, which starts with net income and adjusts for non-cash items and working capital changes. OCF = Net Income + Depreciation & Amortization + Changes in Working Capital. Working capital adjustments: an increase in accounts receivable is subtracted (cash not yet collected); an increase in accounts payable is added (cash not yet paid out); an increase in inventory is subtracted (cash spent building stock). D&A is added back because it reduced net income but required no cash outflow.
Free Cash Flow
Free Cash Flow (FCF) = Operating Cash Flow - Capital Expenditures. FCF represents the cash a business generates after maintaining and expanding its asset base. It is the cash available to pay dividends, repay debt, buy back shares, or fund acquisitions without raising external capital. A business with consistently positive FCF is self-funding. If FCF is persistently negative while OCF is positive, the business is in heavy expansion mode; if both are negative, it is burning cash and needs external funding.
Direct Method for Operating Cash Flow
The direct method builds OCF from actual cash receipts and payments: Cash Received from Customers - Cash Paid to Suppliers - Cash Paid for Operating Expenses - Cash Paid for Taxes = Operating Cash Flow. While more transparent, it requires detailed cash records that many businesses do not maintain separately from their income statement. The FASB encourages the direct method but allows the indirect method, and the vast majority of companies use indirect because the data is easier to extract from existing accounting systems.
Cash Flow Runway
Runway = Current Cash Balance / Monthly Net Cash Burn. If a startup has $600,000 in the bank and burns $75,000 per month in net cash, its runway is 8 months. Runway is the most pressing metric for early-stage businesses because it determines when they must raise capital or reach break-even. Extending runway requires either increasing inflows (accelerating collections, growing revenue) or reducing outflows (cutting costs, delaying capex). A common rule of thumb is to start fundraising when 6–8 months of runway remain.
Common Cash Flow Problems and Fixes
Slow collections extend Days Sales Outstanding and squeeze operating cash. Offering early payment discounts (e.g., 2/10 Net 30 — 2% off if paid within 10 days) can accelerate inflows. Bunching large supplier payments at invoice due dates preserves cash longer. Timing inventory purchases to align with seasonal demand peaks prevents cash from sitting idle in stock. Factoring or invoice financing converts receivables into immediate cash at a cost of 1–5% of the invoice value, useful as a bridge when payment cycles are long.
Try These Calculators
Put what you learned into practice with these free calculators.
Related Guides
How to Calculate Working Capital
Learn how to calculate working capital, the working capital ratio, and the cash conversion cycle, and understand what these metrics reveal about short-term financial health.
How to Calculate Inventory Turnover
Learn how to calculate inventory turnover ratio and days inventory outstanding, why these metrics matter for cash flow, and how to benchmark them by industry.
How to Calculate Revenue Growth Rate
Learn how to calculate period-over-period revenue growth rate, compound annual growth rate (CAGR), and how to use these metrics to evaluate business performance.