Contrary to what many real estate investors think, the cash flow formula is relatively straightforward and not that complicated at all.
Cash flow is an important element in real estate investing. Knowing how to calculate cash flow on a potential investment property will give you an insight into its profitability. It will, in turn, make it easier for you to make the best investment decision, given the options available to you.
Table of Contents
- Why Is Cash Flow an Important Metric in Real Estate Investing?
- 4 Types of Cash Flow Formulas
- Where Can You Find a Reliable Cash Flow Calculator?
Unfortunately, many real estate investors and rental property owners fail to grasp the cash flow concept and implement it in their rental businesses. It is why 30% or nearly a third of rentals, both long and short term, fail (or are failing) due to running out of money. It simply means that such properties generate a negative cash flow.
About 60% of rental property owners say that they don’t understand the cash flow formula and don’t know much about finance and accounting.
Since you’ve opened this article, congratulations on taking the first step toward understanding it. You’re on the right track to being able to monitor your cash flow and grasp anything to do with your rental property’s financial matters.
In this post, we’re going to look at three cash flow formulas, their benefits, and what they tell you about your rental property business. Don’t worry if it looks like an alien concept. We’ll break the formulas down to the beginner level.
Related: How Do You Achieve a Positive Cash Flow in Real Estate?
Why Is Cash Flow an Important Metric in Real Estate Investing?
Before we move any further, let’s define what cash flow is and why it is important in real estate investing.
Cash flow, by definition, is the amount of money left after deducting all the expenses and taxes from your monthly rental income. Simply put, it is what’s left of your income on your long term or short term rental property.
Cash flow helps investors determine whether a property is worth investing in. An investment property with a positive cash flow means you will make enough monthly income. It will help take care of the property and give you a decent enough profit at the same time.
On the other hand, properties with negative cash flow mean you are most likely to spend more money out-of-pocket to keep the rental property operational. It is quite counterproductive where business and investing are concerned.
Factors That Affect Cash Flow
Cash flow can either be positive or negative, depending on several factors. The main things that will determine your cash flow are your rental rate, occupancy rate, and monthly expenses. Below are some of the things that you should consider in your formula when working on a cash flow statement:
One, your rental rate will significantly affect your monthly cash flow in very significant ways. If you’re charging too low for your rental compared to other similar rental properties in the area, you could end up breaking even if you’re lucky enough. Most of the time, underpriced rental properties will lose more money than it makes.
You must consider regular maintenance, property taxes, insurance, repairs, and other day-to-day stuff needed to ensure your rental business’ operating activities run smoothly.
As a rental property owner, you also need to figure out how to get tenants and guests. For landlords, you will need to figure out how to minimize the transition time from one tenant to another to keep the property occupied.
Short term rental property owners, on the other hand, must find ways to improve their occupancy rates and keep their properties booked for more than half the time they are listed. Short term rental properties in high-tourism markets typically thrive, but if the property is in an area where tourism isn’t as high, you will need to be creative with your strategies.
Keep in mind that a vacant property, whether it’s a long term rental or a short term rental, will still cost you money in upkeep. The longer a property is vacant, the more money you lose as an investor.
Lastly, your monthly expenses will significantly impact your cash flow. Let’s take, for instance, a vacation rental property listed on Airbnb.
Airbnb has specific standards that Airbnb owners need to follow and maintain in order to stay qualified as Airbnb hosts. It means you should keep your short term rental in tip-top shape so it complies with Airbnb’s standards.
It entails a lot of hard work and plenty of cash involved. Between maintenance and housekeeping costs, running an Airbnb business can be exhausting and expensive.
On top of the operating expenses, you also need to consider your mortgages (if you took out a loan to buy the property), property taxes, management fees, insurance, and other incidental expenses.
It is why a basic understanding of cash flow and knowing how to calculate it will help you avoid investment mistakes. It doesn’t matter if you do it on paper or by using an Excel spreadsheet as long as you know how to compute it.
4 Types of Cash Flow Formulas
Now that we’ve already discussed the basics of cash flow, let’s move on to the different types of cash flow formulas that you should know.
A wise investor will want to learn how to make a cash flow statement, understand how to read it, and compute a property’s cash flow to determine profitability. Whether you choose to use an Excel spreadsheet or a cash flow formula calculator, the important thing is you know how to do it.
As a real estate investor and potential rental property owner, knowing the following formulas will help you see whether a prospective property is worth buying and converting into a rental property.
1. Free Cash Flow Formula
The free cash flow (FCF) formula is one of the most important cash flow formulas. Most rental property owners use the free cash flow formula to plan and budget. The formula’s main benefit is that it helps you understand how much money is available or free to use.
With the FCF formula, you can answer questions such as:
- Can you afford to pay for upgrades to your property or purchase a new one?
- Do you have enough funds to pay your contractors when they send you an invoice?
- How much cash do you have to spend on maintenance and upkeep?
What Is Free Cash Flow Formula?
Calculating your rental property’s cash flow is relatively straightforward. What you need is your balance sheet or income statement so that you can pull the important numbers.
First, let’s look at the financial metrics you’ll need:
- Net Income: Net Income is the remaining income after deducting all your expenses from the gross rental income. You can call it your profit. You can find the figure in the Income Statement.
- Working Capital: Working Capital represents the capital you need to run the day-to-day operations of your rental property.
- Depreciation/Amortization: Remember, many of your rental property’s assets, including equipment, furniture, and other appliances, will lose value as time goes by.
Depreciation is the metric that measures how much value was lost. On the other hand, amortization is factoring in an asset’s initial cost and breaking it down over its lifetime. You can find the said metrics on your Income Statement.
- Capital Expenditure: Capital expenditure is the money you spend on your property, such as real estate, land, or equipment. You can find the capital expenditure on the Cash Flow Statement.
With this in mind, let’s look at what the formula looks like:
Free Cash Flow = Net Income + Depreciation/Amortization – Working Capital – Capital Expenditure
Free Cash Flow Case Study
Let’s look at a real-life example of how you can apply the above formula to your rental business. Bill runs a short term rental business and wants to calculate his free cash flow. He wants to see if he can afford to hire an accountant to work on his business’ finances.
Bill’s annual financials look like the following:
- Net Income: $100,000
- Depreciation/Amortization: $0
- Change in Working Capital: $12,000
- Capital Expenditure: $3,000
As such, this is how Bill will calculate his business’s free cash flow:
[$100,000] + [$0] – [$12,000] – [$3,000] = $85,000
It means there is $85,000 available in cash for him to hire an accountant to help him figure out his rental business’ finances.
2. Operating Cash Flow Formula
As we’ve seen, free cash flow gives you an idea of how much cash you must reinvest back into your rental property business. However, there’s a slight problem with such an approach; it doesn’t provide a clear picture of your regular daily cash flow. It is because its formula doesn’t factor in any irregular spending, added investments, or earnings.
For example, let’s say you own a few rental properties and decide to sell one of them. Using the previous formula, your free cash flow will increase. However, it doesn’t reflect your actual business cash flow. This is where the operating cash flow formula comes in.
Why is the operating cash flow formula important?
When you’re looking for financing to expand your rental property business, lenders or venture capital firms are more likely to look at your operating cash flow. The operating cash flow represents the typical cash flow for your business. The same applies when you want to start working with a financial advisor or an accountant.
Related: Real Estate Remains Among the Best Cash Flow Investments
What Is Operating Cash Flow Formula?
As we said in the free cash flow above, you also need your business income statement and balance sheet to calculate your operating cash flow.
Also, note that when we refer to Operating Income in the formula, we mean the difference between total revenue and operating expenses, like property management fees, taxes, and upkeep costs. They should all be found in your cash flow statement and factored into your formula.
Here is how you get cash flow from the operations formula:
Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital
Operating Cash Flow Case Study
Following Bill’s business example above, let’s assume this is how his business financials look like:
- Operating Income: $100,000
- Depreciation: $0
- Taxes: $10,000
- Change in Working Capital: -$15,000
Below is the formula that Bill will use to calculate his operating cash flow:
[$100,000] + [$0] – [$10,000] + [-$15,000] = $75,000
As such, Bill makes an annual operating cash flow of $75,000 from his regular operating expenses.
3. Net Cash Flow Formula
Another formula that is quite useful for cash flow statements is the net cash flow formula.
Simply put, Net Cash Flow (NCF) is a metric used to tell the amount of money that went in and out of your rental property’s account within a particular period. If the money that came in was more than the money that went out, the business experienced a positive cash flow. If the opposite is true, the business was operating on a negative cash flow.
The main benefit of NCF is that it lets the landlord or short term rental owner see if their business is doing well or if there’s a risk of filing for bankruptcy. Consistent periods of positive cash flow demonstrate that everything is doing well and indicate a potential for expansion. Inversely, a negative cash flow means the rental property business is struggling.
To calculate your rental property’s NCF, you need to access your cash flow statement and look at the financing activities, investing activities, and operating activities.
Related: Seller Financing: The Ultimate Guide for Real Estate Investors
What Is the Formula for Net Cash Flow?
From how we’ve defined net cash flow, the simple formula would be as follows:
Net Cash Flow = Total Amount of Cash In – Total Amount of Cash Out
However, we can further expand that formula to make it more comprehensive, as follows:
Net Cash Flow = Net Cash Flow from Financing Activities + Net Cash Flow from Operating Activities + Net Cash Flow from Investing Activities
In case you don’t understand, here’s a breakdown of the metrics:
- Net Cash Flow from Financing Activities: The difference between the cash flowing in from financing activities, such as loans, and cash outflows from financing activities, such as loan repayments.
- Net Cash Flow from Investing Activities: The difference between cash inflow from investing activities, such as selling investment property, and cash outflow from investing activities, such as buying other assets.
- Net Cash Flow from Operating Activities: Examples of net cash flow in operating activities include the change in net rental income for a specific period. You can also include the differences to balance the net cash inflow or outflow for your rental business’ operating activities.
Net Cash Flow Case Study
Let’s think of Iman, who wants to calculate her long term rental property’s net cash flow. Below are the numbers she gets from her statement of cash flow:
- Net Cash Flow from Operating Activities: $70,000
- Net Cash Flow from Financing Activities: $20,000
- Net Cash Flow from Investing Activities: -$50,000
Here is what her net cash flow calculations will look like:
[$70,000] + [$20,000] + [-$50,000] = $40,000
Iman realizes a positive cash flow of $40,000 within that specific period. It is a good sign, and she should work to maintain a positive cash flow.
4. Discounted Cash Flow Formula
The last type of formula that you can use on your cash flow statement is the discounted cash flow (DCF) formula.
The DCF formula is used to evaluate the rate of return that an investment property might generate in the future. The formula is used to determine the value of an income property based on the estimated future cash flow of the rental property business. The amount will also depend largely on the rental strategy used.
Rental property owners also use DCF to determine the current value of an investment property by evaluating its financial projections and looking at how much it can earn in the future.
The main benefit of DCF is that it helps rental property investors and owners decide to make changes to their operations and processes, such as purchasing new furniture or appliances.
What Is Discounted Cash Flow Formula?
The DCF formula adds all the cash flows for every reporting period and then divides the total by one plus the discount rate raised to the power of n. Here is what the formula looks like:
DCF = [(Cash Flow) ÷ (1 + r) ＾1] + [(Cash Flow) ÷ (1 + r) ＾2] + [(Cash Flow) ÷ (1 + r) ＾n]
Let’s breakdown the formula as follows to understand it better:
- Cash flow represents your rental property’s free cash flow. Remember, it is the money left after subtracting operating expenses and capital expenditures.
- R represents the discount rate.
Be careful when calculating your rental property’s discounted cash flow formula. Simple inaccuracies in estimating future earnings and return on investment can lead to undesired outcomes.
Also, the main limitation of the DCF formula is that it requires a lot of assumptions. For instance, you need to estimate future cash flows from another potential rental property investment. However, future cash flows depend on market demand, competition, and other unforeseen circumstances.
If you estimate the future cash flows too high, you might end up with an investment property that might not pay off as expected. Estimating too low could make the investment seem too costly and result in missed opportunities.
Where Can You Find a Reliable Cash Flow Calculator?
Now that we’ve understood the important cash flow formulas, you might be wondering how you can actually calculate your rental property’s cash flow. Mashvisor’s rental property calculator is the best tool for doing so, whether you’re earning passive income or managing your properties yourself.
For starters, Mashvisor is a real estate investment software whose main goal is equipping real estate investors with accurate data and the right tools to make smart investment decisions. It can help you come up with highly accurate cash flow statements that will factor in all expenses related to a rental property, such as management fees, taxes, and maintenance costs.
As a real estate platform, Mashvisor has already helped countless investors find the right investment properties and have made crunching the numbers easier for them. You no longer need to worry about manually putting the data in Excel. You can simply use the data available on the system when you use the rental property calculator.
To learn more about how we will help you make faster and smarter real estate investment decisions, click here.
Mashvisor’s Rental Property Calculator
Mashvisor’s rental property calculator uses machine learning and AI algorithms, big data, and predictive analytics. In addition, it comes with interactive capabilities. The tool provides you with accurate estimates for both long term and short term rental strategies. All the said features make it the best tool to calculate cash flow in the market.
The tool carries out the following functions:
1. Estimates Monthly Property Expenses
As we’ve seen with most cash flow formulas, you must factor in property expenses. Mashvisor provides you with accurate projections of the amount of money you can expect to spend when owning and managing a rental property. The expenses include one-time costs, such as closing fees, and recurring expenses, such as maintenance.
Our platform uses rental comps to ensure our data and estimates are accurate. Since the calculator is interactive, you can modify any figure that doesn’t match the market situation.
2. Estimates Monthly Rental Income
Mashvisor also provides reliable estimates for the monthly rental income you can expect to make. It also provides estimates for both long term and short term rental strategies. Just like the monthly expenses, you can also adjust the income projections if your research suggests that things might be different.
3. Calculates Cash Flow
After getting the estimates for expenses and income at hand, Mashvisor’s calculator then helps you calculate your investment property’s cash flow. The cash flow you get is for both long term and short term rental strategies.
You can also adjust the rental income and financing fees to see how they’d affect the cash flow. This way, you can see how you can maximize your rental property’s cash flow.
4. Calculates the Return on Investment
Since it doesn’t account for the total cash invested, cash flow isn’t sufficient to determine whether a rental property is worth investing in. It’s important to calculate the return on investment before you buy investment properties.
Mashvisor’s calculator also calculates return on investment metrics, such as cash on cash return and cap rate for both rental strategies.
To end, understanding what a cash flow formula is and its importance will help you make wiser investment decisions. Owning a rental property takes more than being able to access funding. Several factors come into play as far as your cash flow statement is concerned.
This cash flow formula guide has shown us that the calculations aren’t as complicated as one would think. You want to invest in an opportunity that guarantees you positive cash flow. After all, that’s the only way an investment opportunity would make sense. And the best way to invest in good investment properties is by using Mashvisor tools.
When you sign-up for Mashvisor’s products and services, you are guaranteed to have an easier and more efficient time spotting the best real estate investment deals. You can also conduct highly accurate profitability studies. The platform’s tools will make it easier for you to crunch the numbers so you get an idea of whether a property is worth buying or not.
Sign up today for a 7-day free trial, followed by 15% off of your quarterly or annual subscription.