Understanding Positive Cash Flow: 3 Types of Cash Flow (2023) - Shopify Canada (2024)

To run a business is to be immersed in a constant churn of money changing hands. In a typical business day, money flows from customers to a business, which sends some of that money to employees and suppliers to sustain its normal business operations. If you want your business to survive and thrive, you need your company’s cash inflows to exceed its cash outflows. Accountants call this positive cash flow, and it’s a crucial hallmark of any profitable business.

What is positive cash flow?

Positive cash flow occurs when a company’s cash inflows exceed its cash outflows over a given period. This indicates that the business is generating more cash than it is spending, which is essential for sustaining operations and growth.

What is a cash flow statement?

A cash flow statement is a document that shows a real-time portrait of a company’s gross profit and operating expenses. When a company’s cash flow is positive, it suggests a state of financial health. Companies with positive cash flow can pay their day-to-day expenses, invest in new equipment, pay dividends to shareholders, and attract outside investment. On the other hand, when a financial statement reveals negative cash flows, it suggests the company may not have enough cash to cover its daily business costs and risks insolvency.

But a cash flow statement isn’t the be all, end all of a company’s financial health, because it doesn’t account for future transactions. Cash flow statements only cover monies entering and departing a company over a certain period. Future transactions can still affect the company’s cash flow forecasting and long-term financial performance.

3 types of cash flow

1. Operating cash flow
2. Investing cash flow
3. Financing cash flow

Cash flow turns up in various ways on an income statement. The three common forms of cash flow business owners deal with are operating cash flow, investing cash flow, and financing cash flow. Here’s how they differ:

1. Operating cash flow

A company’s operating cash flow offers a portrait of its day-to-day operating activities: namely, the income from sales and outflows from salaries, vendor fees, lease payments, taxes, and interest payments. A company whose sales exceed its operating expenses is cash flow positive.

2. Investing cash flow

Cash flow from investing activities (CFI) refers to monies linked to long-term investments. When a company invests in, say, a startup, its investing cash flow is negative (more money out than in). When a company cashes out on its investment by selling its startup shares, its investing cash flow is positive.

3. Financing cash flow

Financing cash flow—or cash flow from financing activities (CFF)—refers to the net cash linked to financing activities that power many companies. Some companies sell ownership shares to investors to raise money for operating expenses. Some financing activities bring in money, like selling bonds to generate cash, and others send money out, like paying dividends and buying back stock from investors. For some startups, financing cash flow will play a more significant role than operating cash flow in the company’s overall cash flow management.

Cash flow vs. profit

The terms “cash flow” and “profit” may sound like synonyms, but they describe two different accounting terms. Here’s how they differ:

Cash flow

Cash flow describes net cash or cash equivalents entering and exiting a company within a given period. Cash flow represents the transfer of monies but doesn’t account for sums in accounts receivable (money owed to the company by its clients) and accounts payable (money the company owes to its vendors and suppliers).

For example, a growing startup may routinely spend more money than it makes. While these balances are sometimes reconciled in the long run, these unpaid balances do not impact cash flow statements.

Profit

In accounting terms, profit is the total balance when operating expenses are subtracted from operating revenue—i.e., the difference between the amount earned and the amount spent. It’s a top-line item on a company’s profit and loss statement. Accountants divide profit into three main categories:

• Gross profit. Gross profit is the total cost of the goods sold subtracted from the company revenue. The cost of goods sold includes labor and supplies but does not include higher fixed costs like real estate payments and interest. These fixed costs are owed regardless of production.
• Operating profit. Operating profit is the company’s earnings before interest and taxes (EBIT). This means you only focus on income and expenses from a company’s core business operations, such as labor, supplies, and real estate. Long-term debt and taxes—which are less directly tied to daily business activities—do not factor into operating profit. In other words, if a company makes money from a non-core activity—for example, if an entertainment company receives dividends from an investment in an internet startup—the revenue doesn’t count toward its operating profit.
• Net profit. A company’s net profit accounts for its revenues and all expenses. This means all expenses (i.e., salaries, supplies, taxes, and interest) are subtracted from all revenues (both core and ancillary revenue streams).

How to calculate cash flow

At its core, a company’s cash flow statement reflects this simple equation:

Cash on hand - expenses = cash flow

For instance, if a company brings in $17,000 in a given month, and its expenses are $14,500, it has a positive cash flow of $2,500. Or, if this same company makes $17,000 in a month but spends $23,000, it has a negative cash flow of -$6,000.

Business owners and accountants also use more specific cash flow equations to calculate free cash flow, operating cash flow, and a cash flow forecast. Here’s how to do it:

How to calculate free cash flow

Free cash flow is the money a company generates from its regular operations minus what it spends on capital expenditures. Therefore, the free cash flow equation is:

Free cash flow = cash from operations – capital expenditures

Capital expenditures include property, plant, and equipment (PP&E) expenses, which are then adjusted for appreciation and amortization.

How to calculate operating cash flow

A company’s operating cash flow consists of income and outflows related to day-to-day activities. The operating cash flow formula is:

This formula starts by combining earnings before interest and taxes (EBIT) with various non-cash expenses like depreciation, issued stock, and deferred taxes. It then subtracts changes in working capital, which is the difference between a company’s current assets and liabilities.

How to calculate a cash flow forecast

A cash flow forecast estimates a business’s future sales and expenses. Create a cash flow forecast using this formula:

Ending cash = beginning cash + projected cash inflows – projected cash outflows

Projected cash inflows include unpaid balances in accounts receivable and future payments from investments. Projected cash outflows have outstanding balances in accounts payable and future financial obligations like salaries, supplies, taxes, and interest on debt.