What Is Operating Cash Flow (OCF): A Complete Guide?

Operating Cash Flow

What Is Operating Cash Flow (OCF)?

Operating cash flow (OCF) is the measure of how much cash a company generates from its normal business operations. Operating cash flow indicates whether the company is able to generate enough positive cash flow to sustain and grow its operations. If not, external financing may be required for capital expansion.

  • The key indicator of financial success for a company’s core activities is its operating cash flow.
  • The first section of a cash flow statement is operating cash flow. This includes cash from investments and financing activities.
  • Two methods can be used to show operating cash flow on a cash flow statement: the indirect method or the direct method.
  • Indirect methods start with net income in the income statement to arrive at a cash basis and add non-cash items.
  • The direct method records all transactions during a period using a cash basis. Actual cash outflows are shown on the cash flow statement.

Understanding Operating Cash Flow (OCF)

Operating cash flow is the cash impact of a company’s net income (NI). It comes from its primary business activities. The first section of the cash flow statement is the operating cash flow, also known as cash flow from operations.

The generally accepted accounting practices (GAAP), allow for two methods to present the operating cash flow section: indirect or direct. If the direct method is used, however, the company must still reconcile to the indirect method.

Operational cash flows are cash inflows or outflows that relate to the main business activities of a company, such as buying inventory and providing services. All investing and financing transactions are not included in the Operating Cash Flow section. They should be reported separately. These include borrowing, purchasing capital equipment, or making dividend payments. On a company’s statement, there is an indication of operating cash flow. This can be seen in the company’s statement. It includes cash flows from operations, investment, financing, and cash flows from financing.

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How to Present Operating Cash Flow

Direct Method

The indirect method adjusts net income to a cash basis by using changes in noncash accounts such as amortization and accounts receivables (AR) Most companies report the net income on an accrual basis. This means that it includes non-cash items such as amortization and depreciation.

Adjustments for changes in working Capital accounts must be made to net income. An example: A rise in AR means that revenue has been earned and reported in net earnings on an accrual basis, even though no cash was received. To determine the cash impact of transactions, the AR increase must be subtracted from the net income.

An increase in AP means that expenses were incurred on an accrual basis and have not been paid. To see the cash impact, this increase in AP must be added to net income.

Imagine a manufacturing company reporting a net income in excess of $100 million and operating cash flow in excess of $150 million. This is due to a $150 million depreciation charge, an increase in accounts receivable by $50 million, and a $50 million decrease in accounts payable. This would be shown in the operating cash flow section on the cash flow statement.

  • Net Income $100M
  • Depreciation Add back $150M
  • Increase in AR Less $50M
  • Decrease in AP Less $50M
  • Operating Cash Flow $150M

Direct Method

The direct method is the second. This allows a company to record all transactions on a cash basis, and then display the information using actual cash outflows and inflows for the accounting period. The following items are examples of items that can be included in the presentation for the direct method of operating cash flow:

  • Salary payments to employees
  • Vendors and suppliers are paid cash
  • Customers are able to collect cash
  • Dividends and interest income received
  • Interest paid and income tax paid
  • Operational Cash Flow is important

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Important of Operational Cash Flow

Because they remove certain accounting anomalies, financial analysts may prefer to view cash flow metrics. Particularly, operating cash flow provides a better picture of current business operations.

Booking large sales can provide a significant boost in revenue. However, if the company has trouble collecting the cash, It isn’t a real economic benefit to the company. A company might generate a lot of operating cash flow, but have very little net income if they have a lot of fixed assets or use accelerated deduction calculations.

A company that isn’t generating enough revenue from core business operations will need to seek temporary funding via financing or investing. This is not sustainable in the long term. Operating cash flow is a key indicator of financial stability in assessing a company’s operations.

What are the 3 Types of Cash Flows?

There are three types of cash flows: operating, investing, and financing. All cash generated by the company’s primary business activities is considered operating cash flow. Investing cash flows includes all capital asset purchases and investments in other businesses. All proceeds from the company’s equity and debt, as well as any payments made to it, are considered financing cash flow.

Why Is Operating Cash Flow Important?

It is important to measure operating cash flow. Financial success is determined by the core business activities of a company. It measures the cash generated by normal business operations. The company’s operating cash flow is a measure of its ability to generate enough positive cash flow for growth and maintenance. its operations or external financing may be required for capital expansion.

How do You Calculate Operating Cash Flow?

The indirect method adjusts net income to a cash basis by using changes in noncash accounts such as accounts receivable, depreciation, and accounts payable. Most companies report the net income on an accrual basis. This means that it includes non-cash items such as amortization and depreciation. Operating Cash Flow = Operating Income + Taxes + Changes in Working Capital.

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