Operating Cash Flow: Formula, Calculation And Purpose

In financial accounting, operating cash flow (OCF), cash flow provided by operations, cash flow from operating activities (CFO) or free cash flow from operations (FCFO), refers to the amount of cash a company generates from the revenues it brings in, excluding costs associated with long-term investment on capital items or investment in securities.[1] Operating activities include any spending or sources of cash that’s involved in a company’s day-to-day business activities.[2] The International Financial Reporting Standards defines operating cash flow as cash generated from operations, less taxation and interest paid, gives rise to operating cash flows.[3] To calculate cash generated from operations, one must calculate cash generated from customers and cash paid to suppliers. The difference between the two reflects cash generated from operations.

Operating cash flow (OCF) is a measure of the amount of cash generated by a company’s normal business operations. Operating cash flow indicates whether a company can generate sufficient positive cash flow to maintain and grow its operations, otherwise, it may require external financing for capital expansion.

Cash Flow from Operations (Statement of Cash Flows)

Operating cash flow formula

The operating cash flow is the amount of cash generated by a business, for a specific period, through its normal operating activities within a particular period. When calculating OCF, you generally adjust for things like depreciation, increases in accounts receivable and other noncash and nonoperating expenditures from your net income.

The simplest formula for calculating the OCF is:

Operating Cash Flow = Total Cash Received for Sales – Cash Paid for Operating Expenses

The OCF formula is also written out in other ways, with different terms:

OCF = (Revenue – Operating Expenses) + Depreciation – Income Taxes – Change in Working Capital

OCF = Net Income + Depreciation – Change in Working Capital

OCF = Net Income – Changes in Working Capital + Noncash Expenses

Indirect method for the calculation of OCF

The indirect method of calculating operating cash flow begins with net income from an income statement and adds back noncash entries (such as depreciation, accounts receivable and accounts payable) to get a cash amount. Depending on what information you have about the company’s finances, there are two formulas you can use to calculate OCF using the indirect method.

The first formula for the indirect method to calculate OCF is:

OCF = Changes in Working Capital + Funds from Operations with Funds from Operations

Another formula for the indirect method of calculating OCF is:

OCF = Net Income + Depreciation, Depletion and Amortization + Net Income Adjustments + Changes in Liabilities + Changes in Inventories + Changes in Accounts Receivables + Changes in Other Operating Activities

All the figures included above are generally available as standard line items in cash flow statements.

Direct method for the calculation of OCF

The direct method of calculating operating cash flow tracks all transactions as cash during a financial period and uses actual cash inflows and outflows on the cash flow statement. The direct method for calculating OCF is simple and accurate but does not give investors much information about the company, its operations or its sources of cash. So, GAAP requires that companies still perform a separate reconciliation to the indirect method.

The formula for the direct method for the calculation of OCF is:

Operating Cash Flow = Total Revenue – Operating Expenses

The direct method requires a company to consider all cash amounts paid and received by it. The items will differ from business to business. Some examples of cash items to be considered include:

What is operating cash flow (OCF)?

Why is operating cash flow important?

Operating cash flow represents a company’s overall ability to turn a profit. Generally, a company should aim for a higher OCF, which means it can increase capital without the need for investments or funding. Also, the metrics for OCF should trend upward, indicating an increase in profitability.

A business needs a positive operating cash flow to remain solvent in the long term. A negative OCF means that the company needs to borrow money or raise additional capital to continue meeting its financial obligations.

Financial analysts, investsors and lenders look at a company’s OCF to determine the overall health and profitability of a business. The operating cash flow shows whether the core business activities produce sufficient cash flow for the business to:

Operating cash flow vs. net income

Accounting rules used in generating a business financial statements can cause a difference between a business operating cash flow and its net income. Accounting rules require the use of the revenue recognition principle and the matching of the timing of expenses to revenue, which can result in significant differences between a business operating cash flow and net income.

Operating cash flow example

Take a look at the amounts in the following table to calculate the operating cash flow for a hypothetical business, ABC Corporation, for its financial year-end.

It is useful to compare the OCF calculation for ABC Corporation using both indirect method formulas. Both formulas produce the same results using different types of information.

First indirect method formula

Using the first indirect method formula, funds from the ABC Corporations operations can be calculated like so:

OCF = Changes in Working Capital + (Net Income + Deferred Taxes, Investment Tax Credit + Depreciation, Depletion and Amortization + Other Funds)

OCF = $34.69B + ($59.53B + -$32.59B + $10.9B + $4.9B) = $77.43 billion

Second indirect method formula

Using the second indirect method formula, the OCF for ABC Corporation can be calculated like so:

OCF = Net Income + Depreciation, Depletion and Amortization + Net Income Adjustments + Changes in Liabilities + Changes in Inventories + Changes in Accounts Receivables + Changes in Other Operating Activities

OCF = $59.53B + $10.9B + -$27.694B + $9.131B + $0.828B + -$5.322B + $30.057B = $77.43 billion

FAQ

Is operating cash flow same as EBIT?

Free cash flow is the cash that a company generates from its business operations after subtracting capital expenditures. Operating cash flow tells investors whether a company has enough cash flow to pay its bills.

What is operating cash flow?

Operating cash flow is the money a business generates from its core operations. Net operating income is generally the same as operating income for a company. Operating income is often referred to as earnings before interest and taxes (EBIT), although the two may differ at times.

What are the 3 types of cash flows?

Cash flow from operating activities (CFO) indicates the amount of money a company brings in from its ongoing, regular business activities, such as manufacturing and selling goods or providing a service to customers. It is the first section depicted on a company’s cash flow statement.

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