Operating Cash Flow: Definition, Formula & Examples

Learn everything you need to know about Operating Cash Flow, including what it is, why it's important, and how to calculate it.

Helen Cockle

Operating cash flow is an important metric to understand. It helps you as a business owner understand whether you have sufficient funds to run and grow your organization. Keep reading for our short guide on what operating cash flow is, how to calculate it, and why it is an important metric to understand.

What is Operating Cash Flow (OCF)?

Operating cash flow, also known as cash flow from operating activities, refers to the capital generated through your company's core activities - essentially, it shows how much cash flow is generated from the business operations without regard to secondary sources of revenue like interest or investments. This does not include your expenses either, or long-term expenditures either. It can help you understand if your company is making enough money from its primary activities to maintain and grow the business. Operating cash flow is also important for financial forecasting as it is indicative of the financial health of your company.

Operating cash flow, also known as cash flow from operating activities, refers to the capital generated through your company's core activities.

Operating Cash Flow Formula

The formula for operating cash flow is as follows: Operating Cash Flow = Net Income + Non-Cash Items + Changes in Working Capital.

  • Net income = A business's income minus the cost of goods sold, expenses, depreciation and amortization, interest, and taxes
  • Non-Cash Items = An non-cash expense listed on an income statement, such as capital depreciation, investment gains, or losses, that does not involve a cash payment
  • Changes in Working Capital = The difference in the net working capital amount from one accounting period to the next

The formula for operating cash flow might vary slightly as different businesses won’t always have the same items on their balance sheet.

Indirect & Direct Operating Cash Flow Calculation Methods

There are two main methods of calculating operating cash flows - the indirect and direct methods. Both produce the same result.

  • Direct method: Working with the income statement, you enter operating cash flows as a list of outgoing and incoming cash flows.
  • Indirect method: Starting with the net income, you work backward to achieve a figure for cash basis, applying adjustments for amortization and depreciation (i.e. non-cash items).

Operating Cash Flow Calculation Examples

Operating Cash Flow formula

Company A has a net income of GPB 1,500,000 and a change in working capital of GPB 900,000. Its depreciation, amortization, depletion, and other non-cash expenses total GPB 400,000. The formula would be as follows: Cash Flow from Operating Activities = GPB 1,500,000 + GPB 400,000 + GPB 900,000 = GPB 2,800,000.

Direct method

The direct method converts each item on the income statement to a cash basis. If, for example, Sales of Company A are stated at GPB 100,000 on an accrual basis and accounts receivable increased by GPB 5,000, cash collections from customers would be GPB 95,000. Then, all remaining items on the income statement are converted to a cash basis.

Indirect method

The indirect method starts with the net income and adjusts it for both changes in current assets (other than cash) and current liabilities, and any items that were included in net income but did not affect cash. For example, if Company B had net income for the year of GPB 20,000 after deducting depreciation of GPB 10,000, yielding GPB 30,000 of positive cash flows. Thus, Company B had GPB 30,000 of positive cash flows from operating activities.

Why is Operating Cash Flow important?

To calculate operating cash flow for your business has a couple of perks - it indicates whether your operation has the funds to support its daily running, but also to grow as a business. For instance, companies with a positive operating cash flow will be able to launch initiatives for growth. They can develop new products with the cash generated, come up with new product features or lines, and pay shareholders. Having a good idea of where your business stands will help plan and improve business operations. Also, investors will often specifically look for companies with an upwardly trending cash flow from operating activities.

Operating cash flow vs free cash flow: are they the same?

Free cash flow is different from operating cash flow. It describes the capital your business is left with once capital expenses have been deducted from the operating cash flow. The formula for free cash flow is as follows: Free Cash Flow = Operating Cash Flow – Capital Expenditures. While the two metrics are similar and may be easily confused, it is important to be aware of the difference.

Operating Cash Flow FAQs

  • What is operating cash flow on a cash flow statement?

Operating cash flow is the capital that your business generates through its core business activities (not including expenses, revenue drawn from investments, or long-term capital expenditures).

  • What is a good operating cash flow?

To determine this, you can calculate your business's operating cash flow ratio. This measures how well your company can pay off its current liabilities with the cash flow generated from its core business operations. The formula is as follows: Operating Cash Flow Ratio = Cash Flow from Operations / Current Liabilities. "Current Liabilities" refers to all the obligations that are due within one year. Ideally, your operating cash flow ratio should be greater than 1.

  • What affects operating cash flow?

Operating cash flow is determined by three metrics: net income, non-cash items, and changes in working capital.

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