Operating cash flow | Verified Metrics (2024)

Definition of operating cash flow

Operating cash flow, also known as operating cash or OCF, is a critical financial metric that measures the amount of cash generated from a business's core operations. Businesses of all sizes need to understand and monitor operating cash flow, as it can provide insight into a company's financial stability, efficiency, and ability to generate profits.

Why is operating cash flow important?

Understanding and managing operating cash flow are crucial for businesses of all sizes and industries. Here are some of the main reasons why operating cash flow is essential:

  1. Financial health: A company's operating cash flow can provide insight into its financial stability and ability to generate profits. If a business has a positive operating cash flow, it generates more cash from its core operations than it is spending, indicating that it is financially healthy. On the other hand, a negative operating cash flow may indicate financial strain and the need for additional financing or cost-cutting measures.
  2. Decision-making: Operating cash flow can also be used as a key metric in decision-making, such as evaluating potential investments or financing options. For example, a business with a strong operating cash flow may be more likely to secure a loan or attract investors.
  3. Working capital: Operating cash flow is closely tied to a company's working capital, which is the difference between its current assets and current liabilities. Working capital is essential because it represents a company's ability to pay its short-term debts and meet its financial obligations. A business with a positive operating cash flow typically has sufficient working capital to cover its short-term debts and expenses.
  4. Cash flow forecasting: Operating cash flow can also be used to forecast future cash flow, which can be helpful for budgeting and planning. By analyzing past operating cash flow trends and considering future business plans and economic conditions, businesses can make more informed decisions about allocating their resources and planning for the future.
  5. Comparison with competitors: Operating cash flow can also be used to compare a company's financial performance to its competitors. By comparing operating cash flow ratios, businesses can gauge their financial efficiency and identify areas for improvement.
  6. Stock price: Operating cash flow is also closely watched by investors and analysts, as it can impact a company's stock price. A business with strong operating cash flow is typically seen as more financially stable and attractive to investors, which can increase its stock price.

Operating cash flow is a crucial financial metric that provides valuable insight into a company's financial health, efficiency, and decision-making capabilities. It is crucial for businesses to regularly monitor and manage their operating cash flow to ensure financial stability and success.

Calculation of operating cash flow

There are two main methods companies use to calculate operating cash flow: the indirect method and the direct method. Here is a brief overview of each method:

  1. Indirect method:

The indirect method involves starting with net income, as reported on the income statement, and then adjusting for changes in non-cash items and working capital. This method is generally more common, as it is easier to calculate and does not require detailed information about a company's cash inflows and outflows.

To calculate the operating cash flow using the indirect method, follow these steps:

  • Start with net income, as reported on the income statement.
  • Add back non-cash expenses, such as depreciation and amortization, as these expenses do not involve a cash outflow.
  • Subtract any gains or losses from selling assets, as these do not relate to core operations.
  • Adjust for changes in working capital, such as increases or decreases in accounts receivable, accounts payable, and inventory.
  • Calculate the net change in working capital by subtracting the beginning balance from the ending balance.
  • Add the net change in working capital to net income to determine operating cash flow.

Here is an example of the indirect method calculation:

Indirect Method:

Operating cash flow | Verified Metrics (1)

  1. Direct method:

The direct method calculates operating cash flow by tracking all cash inflows and outflows from core operations. This method is more accurate, as it provides a detailed analysis of a company's operating cash flow. Still, it is also more time-consuming and requires more detailed information about a company's cash transactions.

To calculate the operating cash flow formula using the direct method, follow these steps:

  • Identify all cash inflows from core operations, such as cash received from sales, collections from accounts receivable, and other operating revenues.
  • Identify all cash outflows from core operations, such as cash paid for operating expenses, payments to suppliers, and other operating expenses.
  • Calculate the net cash inflow or outflow from core operations by subtracting cash outflows from cash inflows.

Here is an example of the direct method calculation:

Direct Method:

Operating cash flow | Verified Metrics (2)

The indirect and direct methods of calculating operating cash flow have advantages and disadvantages. Businesses need to understand both methods and choose the one that is most appropriate for their needs. An operating cash flow calculator can also help determine this key financial metric.

Presentation of operating cash flow on financial statements

Operating cash flow is typically reported on the cash flow statement, which is one of the three primary financial statements (along with the balance sheet and income statement). The statement of cash flows provides information about a company's cash inflows and outflows, broken down into three categories: operating activities, investing activities, and financing activities.

Operating cash flow is presented in the "operating activities" section of the statement of cash flows, which is typically the first section. This section provides information about a company's cash flow from its core business operations, such as sales, accounts receivable collections, and operating expenses payments.

To find operating cash flow on the statement of cash flows, look for the line item titled "net cash provided by operating activities" or something similar. This line item represents the net change in operating cash flow over a specific period, typically a month or a year.

Understanding the relationship between operating cash flow and other financial statements is important, as they all provide different but complementary information about a company's financial performance. The income statement, for example, provides information about a company's revenues, expenses, and net income, while the balance sheet shows a company's assets, liabilities, and equity. By analyzing all three financial statements together, businesses can get a more comprehensive view of their financial health and performance.

In addition to the statement of cash flows, operating cash flow can also be calculated using the indirect method, as described in the previous section. An operating cash flow calculator can also be used to help determine this key financial metric.

Difference between operating cash flow and free cash flow

Operating cash flow and free cash flow are two related, but distinct, financial metrics that measure a company's ability to generate cash from its operations and investments. Here is a more detailed explanation of the difference between operating cash flow and free cash flow:

Operating cash flow:

  1. Operating cash flow, also known as operating cash or OCF, measures the amount of cash a business generates from its core operations. It is calculated by adjusting net income, as reported on the income statement, for non-cash items and other changes in working capital. Operating cash flow is important because it provides insight into a company's financial stability and ability to generate profits from its core operations.

Free cash flow:

  1. Free cash flow, also known as FCF, measures the amount of cash a business generates after considering capital expenditures, such as plant, equipment, and other assets. It is calculated by subtracting capital expenditures from operating cash flow. Free cash flow is important because it measures a company's ability to generate cash after accounting for investments in its long-term growth.

Here is an example of the calculation of operating cash flow and free cash flow:

Operating cash flow | Verified Metrics (3)

As you can see in this example, operating cash flow is calculated by adjusting net income for non-cash expenses and changes in working capital. In contrast, free cash flow is calculated by subtracting capital expenditures from operating cash flow.

Businesses need to understand operating cash flow and free cash flow, as they provide different but complementary information about a company's financial performance and ability to generate cash. Operating cash flow is a key indicator of a company's financial health and efficiency, while free cash flow provides insight into a company's ability to generate cash after accounting for investments in its long-term growth. Together, these metrics can provide valuable insight into a company's financial stability and ability to generate profits.

In conclusion, operating cash flow is a critical financial metric measuring the amount of cash a business generates from its core operations. Operating cash flow represents a company's ability to generate profits.

There are two main methods for calculating operating cash flow: the indirect method and the direct method. The indirect method is more common, as it is easier to calculate, while the direct method is more accurate but requires more detailed information about a company's cash transactions.

Operating cash flow | Verified Metrics (2024)

FAQs

What is the operating cash flow metric? ›

The operating cash flow ratio is a measure of how readily current liabilities are covered by the cash flows generated from a company's operations. This ratio can help gauge a company's liquidity in the short term.

What is a good operating cash flow percentage? ›

A good operating cash flow margin is typically above 50%. If a company has an operating cash flow margin of below 50%, this suggests that the company is not efficiently making sales into cash, and instead, may have high expenses.

How do you verify cash flow statements? ›

How do you audit and verify the cash flow statement using the direct method?
  1. Review the cash receipts and payments. ...
  2. Reconcile the cash balances. ...
  3. Trace the cash flows to the income statement and the balance sheet. ...
  4. Evaluate the reasonableness and completeness of the cash flows.
Apr 16, 2023

How do you calculate operating cash flow KPI? ›

Using the income statement, calculate the operating cash flow KPI by adding the net income and the non-cash expenses, then subtracting any working capital increases.

How to calculate the operating cash flow? ›

The simplest formula goes like this:
  1. Operating cash flow = total cash received for sales - cash paid for operating expenses.
  2. OCF = (revenue - operating expenses) + depreciation - income taxes - change in working capital.
  3. OCF = net income + depreciation - change in working capital.

How to measure good cash flow? ›

A basic way to calculate cash flow is to sum up figures for current assets and subtract from that total current liabilities. Once you have a cash flow figure, you can use it to calculate various ratios (e.g., operating cash flow/net sales) for a more in-depth cash flow analysis.

How much cash flow is enough? ›

When it comes to cash-flow management, one general rule of thumb suggests enough to cover three to six months' worth of operating expenses. However, true cash management success could require understanding when it might be beneficial to invest some cash elsewhere as well.

What is the ideal cash flow ratio? ›

A ratio of greater than one indicates that you're not at risk of default. Because this ratio shows sufficient cash flow to pay off debt plus interest, it should be as high as possible.

What indicates a good cash flow? ›

Positive cash flow indicates that a company's liquid assets are increasing, enabling it to cover obligations, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges.

What are the common mistakes in cash flow statement? ›

Some common mistakes that can lead to cash flow issues include forced growth, miscalculation of profits, insufficient planning for a lean period or crisis, problems collecting payments and more.

How to audit cash flow? ›

  1. 1 Understand the business. The first step is to understand the nature and operations of the business, and how they affect its cash flows. ...
  2. 2 Plan the audit. ...
  3. 3 Test the controls. ...
  4. 4 Perform the substantive procedures. ...
  5. 5 Review the presentation. ...
  6. 6 Report the findings. ...
  7. 7 Here's what else to consider.
Sep 20, 2023

How to interpret a cash flow statement? ›

A cash flow statement provides data regarding all cash inflows that a company receives from its ongoing operations and external investment sources. The cash flow statement includes cash made by the business through operations, investment, and financing—the sum of which is called net cash flow.

What is the metric for cash flow? ›

Cash management efficiency is measured through metrics like cash conversion cycle, days sales outstanding, accounts payable days, cash to cash cycle time, and cash flow forecast accuracy. By tracking these metrics, businesses can identify areas for improvement to optimize cash flow.

How do you assess operating cash flow? ›

Operating cash flow (OCF) is how much cash a company generated (or consumed) from its operating activities during a period. The OCF calculation will always include the following three components: 1) net income, 2) plus non-cash expenses, and 3) minus the net increase in net working capital.

How do you analyze cash flow from operating activities? ›

Prepare your cash flow analysis: Step by step
  1. Identify all sources of income. The first step to understanding how money flows through your business is to identify the income that regularly comes in. ...
  2. Identify all business expenses. ...
  3. Create your cash flow statement. ...
  4. Analyze your cash flow statement.

What is the operating cash flow? ›

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.

Is operating cash flow the same as EBIT? ›

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 is the cash flow valuation metric? ›

The price-to-cash flow (P/CF) ratio measures the value of a stock's price relative to its operating cash flow per share. The price/earnings-to-growth (PEG) ratio is a company's stock price to earnings ratio divided by the growth rate of its earnings for a specified time period.

What is the P FCF metric? ›

The Price to Free Cash Flow Ratio, or P / FCF Ratio, values a company against its Free Cash Flow. It is the Share Price of the company divided by its Free Cash Flow per Share. This is measured on a TTM basis and uses diluted shares outstanding.

Top Articles
Latest Posts
Article information

Author: Msgr. Benton Quitzon

Last Updated:

Views: 6521

Rating: 4.2 / 5 (63 voted)

Reviews: 86% of readers found this page helpful

Author information

Name: Msgr. Benton Quitzon

Birthday: 2001-08-13

Address: 96487 Kris Cliff, Teresiafurt, WI 95201

Phone: +9418513585781

Job: Senior Designer

Hobby: Calligraphy, Rowing, Vacation, Geocaching, Web surfing, Electronics, Electronics

Introduction: My name is Msgr. Benton Quitzon, I am a comfortable, charming, thankful, happy, adventurous, handsome, precious person who loves writing and wants to share my knowledge and understanding with you.