Cash Flow from Operations (Statement of Cash Flows)
Operating cash flow formula
The amount of cash generated by a company for a given period through its regular business operations is known as the operating cash flow. Depreciation, increases in accounts receivable, and other noncash and nonoperating expenses from your net income are typically taken into account when calculating OCF.
The simplest formula for calculating the OCF is:
Total Cash Received for Sales – Cash Paid for Operating Expenses equals Operating Cash Flow.
There are additional ways to express the OCF formula using various terms:
OCF is calculated as (revenue minus operating expenses) plus depreciation, income taxes, and changes in working capital.
OCF is the sum of net income, depreciation, and any changes to working capital.
Net income less changes to working capital plus noncash expenses equals OCF.
Indirect method for the calculation of OCF
The net income from an income statement is the starting point for the indirect method of calculating operating cash flow. Noncash entries, such as depreciation, accounts receivable, and accounts payable, are then added back to produce a cash amount. There are two formulas you can employ to compute OCF using the indirect method, depending on the information you have regarding the company’s finances.
The first formula for calculating OCF using the indirect method is:
Working capital changes plus funds from operations are combined to form OCF.
Another formula for the indirect method of calculating OCF is:
OCF is calculated as net income plus depreciation, amortization, and net income adjustments, as well as changes in liabilities, inventories, receivables, and other operating activities.
All of the aforementioned figures can typically be found in cash flow statements as standard line items.
Direct method for the calculation of OCF
The direct method of calculating operating cash flow uses actual cash inflows and outflows on the cash flow statement and tracks all transactions during a financial period as cash. Although the direct method for calculating OCF is straightforward and precise, it does not provide investors with much knowledge about the business, its operations, or its cash sources. Consequently, GAAP mandates that businesses continue to conduct a separate reconciliation to the indirect method.
The direct method for calculating OCF has the following formula:
Operating Cash Flow = Total Revenue – Operating Expenses
When using the direct method, a business must take into account all cash payments and receipts. 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?
The ability of a business to make money overall is shown by its operating cash flow. A company should generally strive for a higher OCF because it will enable it to increase capital without the need for funding or investments. Additionally, OCF metrics should be on the rise, indicating a rise in profitability.
For a company to sustain long-term viability, its operating cash flow must be positive. If the OCF is negative, the business will need to borrow money or raise more capital in order to continue paying its debts.
OCF is used by financial analysts, investors, and lenders to assess a company’s overall health and profitability. The operating cash flow demonstrates whether the primary business operations generate enough cash flow for the company to:
Operating cash flow vs. net income
The net income of a business and its operating cash flow may differ depending on the accounting rules used to produce the financial statements. Due to the revenue recognition principle and timing requirements imposed by accounting regulations, there may be large discrepancies between a company’s operating cash flow and net income.
Operating cash flow example
Look at the numbers in the following table to determine the operating cash flow for a fictitious company, ABC Corporation, for the end of its fiscal year.
Comparing the OCF calculation for ABC Corporation using the two indirect method formulas is helpful. Using various types of information, both formulas yield the same results.
First indirect method formula
Funds from the operations of the ABC Corporation can be calculated using the first indirect method formula as follows:
OCF is equal to changes in working capital plus (net income minus deferred taxes, investment tax credit, plus depreciation, depletion, and amortization, plus other funds).
OCF = $34. 69B + ($59. 53B + -$32. 59B + $10. 9B + $4. 9B) = $77. 43 billion.
Second indirect method formula
The second indirect method formula can be used to determine ABC Corporation’s OCF in the following manner:
OCF is calculated as net income plus depreciation, amortization, and net income adjustments, as well as changes in liabilities, inventories, receivables, and other operating activities.
OCF = $59. 53B + $10. 9B + -$27. 694B + $9. 131B + $0. 828B + -$5. 322B + $30. 057B = $77. 43 billion.
FAQ
What is operating cash flow?
The amount of money a company earns from its ongoing, regular business activities, such as producing and selling products or offering customers a service, is known as cash flow from operating activities (CFO). It appears as the company’s first section on the cash flow statement.
How do you calculate operating cash flow?
- OCF is calculated as (revenue minus operating expenses) plus depreciation, income taxes, and any changes to working capital.
- OCF is the sum of net income, depreciation, and working capital changes.
- Net income less changes to working capital plus non-cash expenses equals OCF.
Is operating cash flow same as EBIT?
The cash that a company generates from its business operations after deducting capital expenditures is known as free cash flow. Investors can determine if a company has enough cash flow to pay its bills by looking at its operating cash flow.
