What is Operating Cash Flow?

Operating Cash Flow Definition

Operating cash flow (OCF) is the company's total cash from operations. It shows how much money comes from selling products or services on the financial statement and follows cash basis accounting principles.

A cash flow statement's OCF section provides a detailed cash generation summary. It can be tracked using accounting software like an AR automation tool. 

Operating Cash Flow Calculation

Companies can calculate OCF using the indirect and direct methods and the distinct operating cash flow formula.

Indirect Method

Net Income: Begin with the net income figure from the income statement.

Adjust Non Cash Item:

• Add back any depreciation and amortization since these are non cash expenses that reduce net income but don't impact cash flow.

Adjust Working Capital Changes:

• Subtract extra working capital (accounts receivable, inventory) because they represent cash tied up in operations.
• Add decreases in working capital (accounts payable) since they represent cash released from operations.

Operating Cash Flow = Net Income + Non Cash Expense + Decreases in Working Capital - Increases in Working Capital.

This formula results in operating cash flow.

There are two other ways to calculate operating cash flow. 

The Indirect Method shows how net income from the income statement translates into operating cash flow, highlighting non-cash transactions and working capital changes on cash generated by operations.

Direct Method

Formula: 

OCF Ratio = Cash Receipts from Customers - Cash Payments to Suppliers and Employees

This approach shows actual cash transactions, including where it comes from and where it is spent. 

Note: Net cash flow includes all cash inflows and outflows from operating, investing, and any financing activity.

A company with a substantial OCF value shows efficient operations management, which leads to a positive cash flow ratio. On the contrary, lower OCF values can indicate a negative cash flow. A negative operating cash flow shows that a company spends more cash than it generates. 

Operating Cash Flow Example

Imagine a company starts the year with a net income of $100,000. 

It incurs a $20,000 operating expense, a non-cash charge that reduces its net income but does not affect its cash balance. 

Additionally, the company's accounts receivable decreased by $5,000, indicating it collected more cash from customers than it recognized in sales. However, its inventory increased by $10,000, meaning it spent money to acquire more than it sold. 

Its accounts payable increased by $3,000, showing it owes more to suppliers than at the start, which is cash it has not yet paid out.

To calculate the operating cash flow, you must:

1. Start with a net income of $100,000.
2. Add back the non-cash depreciation expenses of $20,000.
3. Add the decrease in accounts receivable of $5,000.
4. Subtract the increase in inventory of $10,000.
5. Add the increase in accounts payable of $3,000.

The operating cash flow ratio for the year is $118,000. 

This figure represents the cash generated from the company's regular operations, showing how much money is left over to fund expansion, pay dividends, or reduce debt.

Note: OCF is recorded as a current asset and current liabilities on the balance sheet. It also adjusts for non cash items, like depreciation and amortization. 

Operating Cash Flow Importance

Effective cash flow management strategies help optimize operating cash flow.

• Financial Health: OCF displays a company's ability to generate cash from operations. This reflects how well they sustain and grow without financial reliance.
• Liquidity Position: It helps understand a company's ability to pay current liabilities with generated cash. 
• Operational Efficiency: This metric reveals how efficiently a company converts its credit sales into cash. 
• Strategic Decisions: Operating cash flow informs decisions on investing activities, expansion, and improvements.
• Financier Confidence: A solid operating cash flow can attract and retain investors by showing that the company has a solid foundation for generating profit and covering expenses.
• Capital Allocation: Operating cash flow guides companies in effective capital allocation, ensuring investments into new projects, R&D, or expansion.
• Long-Term Continuance: A consistent positive operating cash flow suggests a company's long-term viability, reflecting sufficient cash flow to maintain operations over time.
• Financial Risks: By maintaining healthy cash flow from operations, companies can manage financial risks associated with volatile markets or economic downturns.
• Creditworthiness: Lenders and investors view companies with strong operating cash flows as having lower credit risks.
• Debt Management: A seamless operating cash flow helps companies manage and reduce debt by using the cash from operations to clear debt obligations.

Note: A cash flow calculator can be a crucial tool for businesses to estimate their operating cash flow.

Operating Cash Flow and Other Metrics

In this section, you can find out how OCF differs from other commonly used financial KPIs. 

Operating Cash Flow vs. Free Cash Flow

Operating cash flow represents the cash generated. It shows whether a company can maintain or grow its operations without external financing. It focuses on cash inflow and cash outflow through selling products or services. 

Free cash flow takes operating cash flow a step further by subtracting the capital expenditure (funds to acquire or upgrade physical assets like property or equipment). This shows a company's cash available after maintaining or expanding its asset base. Free cash flow is crucial for investors since it provides insight into the company's ability to generate money.

While both metrics are vital for assessing a company's financial performance, operating cash flow focuses on core business efficiency, and free cash flow shows flexibility broadly. 

Operating Cash Flow vs. EBITDA

EBITDA measures a company's operating performance. It calculates earnings before deducting interest expenses, taxes, depreciation, and amortization. By removing financing, accounting decisions, and taxes, EBITDA focuses on a company's profitability.

It estimates the company's potential earnings but doesn't consider cash flow or capital expenditure.

While OCF emphasizes the cash a company generates and uses daily, indicating liquidity and immediate financial health, EBITDA approximates operating profitability, excluding non-operational costs and non-cash charges. 

Operating Cash Flow vs. Net Income

Net income is a company's profit after subtracting all its expenses from its total revenue. This includes the cost of goods sold (COGS), operating expenses, interest on debt, and taxes. Net Income provides an overall profitability snapshot over a period, including earnings from its core operations and non-operational activities like investments and one-time events.

Operating Cash Flow vs. Operating Income

Operating income is the profit realized from a company's business operations before interest and taxes. It is calculated by subtracting operating expenses, including COGS, from gross revenue. Operating income focuses on the company's earnings from financing activities, excluding non-operational income and expenses, interest, and taxes. 

FAQs

How do I calculate operating cash flow?

To calculate operating cash flow, subtract operating expenses from operating revenues and adjust for changes in working capital.

What are the 3 types of cash flows?

The three types of cash flows are operating cash flow, investing cash flow, and financing cash flow.

Is OCF and CFO same?

OCF and CFO are the same regarding cash flow from operating activities.

What is the difference between operating cash flow and cash flow from operations?

There is no difference; "operating cash flow" and "cash flow from operations" are synonymous terms referring to the same financial metric.