Cash flow in COMMITLY explained: an overview of the direct method with operating cash flow, investing, financing and free cash flow.
COMMITLY uses the so-called direct method to determine cash flow. Cash-effective income is netted against cash-effective expenses.
In other words: we calculate the difference between inflows and outflows on your accounts.
To interpret these movements as well as possible, we further divide the inflows and outflows into three groups:
Operating cash flow, or cash flow from operating activities
Operating cash flow shows to what extent your company is able to finance itself. Hmm, in plain words, that means:
If all ongoing income (inflows) in a period is higher than all ongoing expenses (outflows), you are in the green.
Cash flow from investing activities
It shows whether your company has made investments or sold assets. If your operating cash flow pot is full, you can make investments from your business activities, e.g. buy a new workstation including PC equipment.
If that is not the case, cash flow from financing activities can help.
Cash flow from financing activities
It shows to what extent your company has taken out or repaid loans, made payments to shareholders (dividends) or received payments from shareholders. A classic owner's withdrawal beyond the owner's salary also falls into this category.
Why are these pots so important?
Because they reflect the financial strength of your company best. The example above shows the best case: business is going so well that you generate a surplus from your ongoing income, can invest, and still have something left over. This is called free cash flow.
Free cash flow?
Free cash flow, if positive, is freely available. This means: you have covered all ongoing expenses, made investments, and there is still something left over. Congratulations!
But what to do with it?
Build up a liquidity buffer as a precaution
Invest in new projects or employees (growth)
Repay loans early
Withdraw profits
etc.
And if operating cash flow is negative?
Every business owner knows this situation: in one month, incoming payments are delayed and not all expenses can be paid smoothly. Lucky are those who have built up a cash buffer from previous periods.
If there is none, only cash flow from financing helps, in short: dipping into your own savings or going to investors or the bank.