Types of Cash Flow: Operating, Investing, and Financing

Cash flow is the movement of money in and out of a business during a specific accounting period. When reviewing your financing statements, you’ll find either a negative or positive net cash flow, depending on whether your company spends more than it makes or makes more than it spends.

Your cash flow comes from three activities:

• Operating
• Investing
• Financing

This article discusses the types of cash flow and how they might impact your business.

What is cash flow?

Cash flow is the net amount of money that moves in and out of your business during a given period. This includes all money your company makes and spends.

Your company’s cash flow statement provides a detailed look at how your business’s cash has moved during this period, which could be monthly, quarterly, or annually. It essentially shows you where your money came from and where it went, offering an important assessment of your business’s financial health. This assessment is important when forecasting and to show investors.

Your company’s goal should be to generate a positive flow of cash, indicating that you can cover future financial obligations and expenses because your current assets are increasing—in other words, you’re successfully operating and making money.

Of course, not every business will be immediately profitable. In fact, most startups take two to three years to turn a profit. But as you grow and build your company, showing a positive cash flow can help you attract investors if your small business wants to expand into new markets, upgrade systems to better reach current markets, and more.

The 3 main types of cash flow

We break down each type of cash flow and give the formula for each source. We also share some common items that fall under each type of cash flow.

If this seems intimidating, don’t worry. You can always hire a financial analyst to review your company’s cash flow. Upwork can connect you with independent experts to help you understand your company’s financial performance.

Cash flow from operations (CFO)

Your operating cash flow measures the cash generated or consumed by your company’s standard operating activities—in other words, sales, bills, and wages. These core business activities can include generating revenue by providing services to your customers or producing and selling goods, paying expenses, or funding working capital.

The cash flow from operating activities is found in the first section of your cash flow statement. This number is integral to your business’s financial health. It shows where and how money is being spent and offers insight into your company’s operations and where you make improvements. It also shows how much cash your company has available to finance your business’s growth and new endeavors.

You can calculate your company’s operating income cash flow in two ways: the indirect method and the direct method.

With the indirect method, you’ll add your business’s net income, your non-cash expenses (such as depreciation  and amortization), and changes in your working capital using the following formula:

Operating Cash Flow = Net Income + Non-Cash Expenses + Changes in Working Capital

The direct method actually tracks all your business’s cash transactions during a specific period. It uses your company’s actual cash receipts to determine your operating cash flow.

Unlike accrual accounting, which recognizes earned revenue, the direct method instead focuses on payments received from customers and money paid to suppliers. While it provides greater detail about your operating cash flow, it tends to be more time-consuming and difficult.

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Items to include

The following items would fall under your business operations cash flow.

• Cash received from sales of goods. The money you make from products your company manufactures and sells is considered a cash inflow and is a big part of your operational cash flow.
• Purchase of day-to-day supplies. Money spent on daily supplies for your company to do business is subtracted from any sales made as a cash outflow.
• Purchase of inventory. The cost of inventory purchased—merchandise through a third party you resell or the supplies needed to manufacture your goods—is also subtracted from your operational cash flow total as a cash outflow.
• Utility bills. The cost of utility bills is another type of cash outflow included in your operational cash flow.
• Employee wages. Salaries and wages spent during a specific accounting period are also considered cash outflow.
• Changes in accounts receivable and payable. These affect your working capital and your operational cash flow.

Cash flow from investing (CFI)

This section of your cash flow statement shows how much money your company has spent or made through investment activities during specific accounting periods. These activities can include purchasing assets—such as equipment, property, factories (which are, essentially, fixed assets and long-term assets)—mergers with and acquisitions of other companies, and investments in marketable securities like stocks and bonds.

To calculate your cash flow from investing activities, you’ll subtract the money your business has spent on buying assets or on loans from the money your company has received from the sale of assets and any amounts collected on loans.

Investing Cash Flow = Money Received From the Sale of Assets and any Amounts Collected on Loans - the Money Spent To Buy Assets and/or Loans

Items to include

While we’ve talked a bit about some investing activities that might be included in this section of your cash flow statement, let’s take a closer look at some of them.

• Purchase of investments in the market. If your company makes any investments in marketable securities, such as stocks and bonds, it’s considered a cash outflow.
• Acquisition of a business. This includes any payments related to merging with or purchasing another company.
• Loans. The collection of advanced loans or debt repayment is considered an investing activity on your cash flow statement.
• Purchase of a fixed asset. Also called capital expenditures or cash equivalent, this cash outflow includes the purchase of any property, plant, or equipment your company makes (and the sale of these items would be a cash inflow).

These assets depreciate over time, reducing the amount of taxes you’ll pay. For many companies, positive cash flow from operations is used to offset the negative cash flow from investing. Profitability comes as investments are paid down.

Cash flow from financing (CFF)

The final section of your cash flow statement is the net amount of funding your company generates over a specific period of time. Essentially, your cash flow from financing activities boils down to how your company’s cash moves among its owners, investors, and creditors. This section includes your business’s long-term debts, equity, and dividends.

To calculate your financing activities cash flow, use the following formula:

Cash Flow From Financing = Cash Gained by Equity – (Dividend Payments + Repurchase of Equity)

Items to include

The variables used to calculate your financing cash flow are:

• Cash gained by equity. This cash inflow from external lenders can refer to both short-term and long-term borrowings. These lenders become partial owners in exchange for providing financing.
• Dividend payments. This cash outflow pays dividends to everyone who has invested in your company. These could be recurring or a one-time cash payment.
• Repurchase of equity. Another cash outflow, this refers to the repurchase of shares in your company that were previously issued and traded. This reduces the number of shares in circulation, reducing your company’s net dilution (i.e., the reduction of existing stockholders’ ownership percentage in a company due to the issuance of additional stocks).

What about free cash flow?

Your company’s free cash flow is the total cash that remains after your business pays its operational expenses and any anticipated capital expenditures—meaning any physical assets you’re planning to purchase, like property and equipment.

Free cash flow isn’t considered the same type of cash flow as operating, investing, or financing. It’s more of a measure of performance and indicates how well your company is doing.

Free cash flow measures changes to your working capital and is especially important to investors. It shows them the health of your company (both your assets and current liabilities), trends in your business, and the cash liquidity you can invest.

In short, it helps them evaluate whether they want to invest in your company by showing them your business’s ability to survive and grow. It’s one of the key metrics used in company valuation.

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Categorize your cash flow the right way

Generating accurate and comprehensive cash flow statements for each accounting period is integral to the success of your business. Without this information at your fingertips, you’ll lack valuable data about how your different cash flows affect your profitability and how attractive your business might be to investors.

Preparing these important documents can be overwhelming and intimidating even for seasoned business owners. If you lack the time, wherewithal, or in-house talent to create your cash flow statements, Upwork can help you reach a pool of independent financial analysts. These independent workers can help you produce and evaluate a statement of cash flows, balance sheets, income statements, and other important financial statements and documents.

Our network of professionals can help you better assess your company’s financial health, ensure you have enough cash to meet your obligations, and take your business to the next level.