Net cash flow is the difference between the cash coming into a business versus the cash going out.
Knowing what net cash flow is, how it is calculated, and understanding how to interpret the calculations are all essential to running a successful business.
A simple explanation of calculating net cash flow is subtracting expenses and liabilities from the total cash in a business - but we will cover that more later. The calculation can help assess many business metrics like gains and losses over time, the financial stability of the company, and can be used to make business decisions.
What is Net Cash Flow?
Before we tackle how to calculate net cash flow, let’s first discuss what makes up the cash flow of a business. There are three components that are the core of a cash flow statement of any business.
Operational Activities - the standard operating costs of running a business, like administrative expenses or receiving rent from a tenant.
Financial Activities - made up of inflows and outflows of the money used to fund the company. Examples include dividend and debt payments, issuing and selling stocks, and small business loans.
Investment Activities - these activities include the principal amount of loans, investing in improvements for the business, and the interest earned and paid on investments.
Additionally, under Generally Accepted Accounting Principles (GAAP), disclosure of non-cash activities is sometimes included. For example, in real estate, depreciation of a property is a non-cash expense.
Using these activities, you can calculate net cash flow.
Calculating Net Cash Flow
As explained above, to calculate net cash flow, you subtract expenses and liabilities from the total cash the business has.
The actual calculation is Net Cash Flow = Total Cash Inflows - Total Cash Outflows.
Another name for the total cash inflows when looking at real estate investments specifically is Net Operating Income (NOI). It is calculated by subtracting operating expenses from a property’s revenues. NOI is different from the net cash flow because it does not account for debt service payments, interest income, income taxes or depreciation, and capital expenditures.
So, say for instance, a business generates $300,000 in revenue. The operating expenses are $90,000. The NOI would be $210,000. The same business also has $20,000 in debt service payments and $10,000 in capital expenditures. Therefore, the net cash flow for the business would be $180,000.
Net Cash Flow and Real Estate Investments
Net cash flow can help business owners understand the ebbs and flows of their business, but savvy real estate investors can even use certain investing methods to increase cash flow or get a better return on their investment.
For example, a 1031 exchange can be used to exchange one investment into another property, gaining the ability to defer capital gains taxes. The cash from the deferral can then be reinvested, increasing the return on investment.
Another scenario is if an investor is in a low-cash flow investment. They can use a 1031 exchange to replace the property with a high cash flow property and still get the tax deferral. This leads to higher cash flow projections and long-term appreciation potential.
There are many possibilities to increase net cash flow using methods like a 1031 exchange, and it is best to sit down with an advisor to find the best ways to increase cash flow and return on investments.
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