What is Operating Cash Flow Formula? (OCF Formula)
When you run a business, it's crucial to have an awareness of cash flow metrics. This practice ensures good accounting, but it also gives you an accurate picture of your finances when speaking with investors and stakeholders.
Operating cash flow is one of the amounts you should calculate and monitor regularly. In this post, we'll explain what operating cash flow is, why it matters, and how to use the operating cash flow formula.
Here’s What We’ll Cover:
What is Operating Cash Flow?
Operating cash flow, also known as "cash flow from operating activities" (CFO), is a representation of the amount of cash that a company generates from normal and recurring business activities.
Operating cash flow is present on a company's cash flow statement, which illustrates the holistic picture of all operating activities, investments, and financing.
What Does Operating Cash Flow Reveal?
Operating cash flow reveals the money earned from typical business operations and from the revenue that the company earns over a set period. Operating cash flow does not include:
- Costs from long term investments
- Capital expenses
- Investments in securities
How is It Different From Net Income?
While net income demonstrates earned profit, total OCF changes with the operating activities of a company on a daily basis. Cash flow from operations is reflected on the cash flow statement.
Net income is the starting point for calculating operating cash flow. From an accounting perspective, net income is reflected on the income statement first.
A high OCF indicates that a company has more cash coming in than going out. Net income helps determine OCF, but both are helpful in tracking cash changes and financial health.
Who Uses Operating Cash Flow?
Since operating cash flow illustrates sustainability (based on the business model and core business activities), anyone with a financial stake in the company should take notice.
Additionally, cash flow is important for company growth. Investors may look at this figure to determine whether a business is profitable, or if it requires capital investments to move the bottom line.
How Do You Calculate Operating Cash Flow?
A basic operating cash flow formula is as follows:
Operating cash flow (OCF) = Revenue (cash received from sales) - Operating expenses (paid in cash)
Keep in mind that based on your business operations and financial needs, the operating cash flow formula could be written using different terms. For instance, you might see an operating cash flow calculator that includes terms like net income, depreciation, working capital, and income tax.
The simple operating cash flow equation above is a starting point for calculating this financial measurement.
What is the Indirect Method of Operating Cash Flow?
If you choose an operating cash flow calculator that uses the indirect method, remember that this option is more complex.
The indirect method of operating cash flow involves adding in expenses from depreciation, and it eliminates any revenue earned from investments. Although different, the indirect method still provides a clear way to see your cash flow and business health.
Indirect Operating Cash Flow Formula
The formula for operating cash flow using the indirect method is:
Operating Cash Flow (OCF) = Net Income (Revenue - Expenses/Taxes) + Depreciation
Standard Operating Cash Flow Example
Using the simple OCF equation above, we can determine the operating cash flow amount for a small local catering company that has generated $75,000 in sales during the first year in operation.
- Revenue (cash received from sales) is $75,000
- Operating expenses (for food, supplies, equipment) is $35,000
In this example, an OCF of $40,000 would appear on the catering company's cash flow statement.
Indirect Operating Cash Flow Example
To calculate operating cash flow with the indirect method, you'll need a few other financial metrics (using your company's bookkeeping or accounting software).
We can apply this OCF example to a small mobile computer repair service, keeping in mind that some of the company's equipment (such as laptop, tablet, and vehicle for transportation) likely experienced depreciation over time.
- Net income (cash after expenses are accounted for) = $45,000
- Depreciation = $3,000
In this example, an OCF of $48,000 would appear on the catering company's cash flow statement.
Why is Operating Cash Flow Essential?
Operating cash flow (OCF) is important because it provides a more accurate picture of the cash flow that a company maintains through core business operations only. In other words, it does not include income from secondary sources that could be in use to keep the company afloat.
A business might be generating money from additional outlets (by making investments or offering interest-based credit to customers), but if the actual operating income is negative, then the business may be hurting.
Companies should use operating cash flow (OCF) to verify that their primary reason for existence is both sustainable and profitable.
More Accounting Resources for Businesses
- What is Cash Flow? Almost Everything You Need to Know
- What is a Cash Flow Statement? Definition and Importance
- What Are Investment Activities? How to Report Investment Activities on the Cash Flow Statement