Operating Cash Flow

To say that cash flow is an important financial metric to grasp is, to say the least, a bit of an understatement.

If your business doesn’t have sufficient cash flowing through its accounts, then you’re going to have a hard time paying your bills and could quite possibly end up insolvent.

So, you’re going to want to have a pretty close eye on cash flow.

But cash comes in from—and goes to—different activities. Don’t we want to know a little more than just how much we have left in the bank account each month?

That’s why we break the cash flow statement down into three sections, arguably the most important of which is operating cash flow.

What Is Operating Cash Flow?

Operating cash flow is a measure of how much money your company generates from the core activities it engages in.

It goes by a few pseudonyms:

• Net cash flow from operating activities
• Cash flow from operating activities
• OCF

Whatever you want to call it, you’ll typically find operating cash flow near the top of the cash flow statement, like this:

So, if you’re an ecommerce business selling custom-printed tees, then your operating cash flow tells you how much cash you made selling them after paying for the stuff that goes into it (like buying the ink and the blank garments).

Sounds a little bit weird, right? Isn’t that just cash flow?

Well, once you understand the other two sections of the cash flow statement, you’ll get an idea of why OCF is an important metric on its own.

Cash flow from investing activities lists cash inflows and outflows from capital expenditures. For example, if your clothing company bought a new printing machine or sold off a bunch of old machinery it no longer uses, you’ll find these under cash flow from investing activities.

Learn more about cash flow from financing in our guide

Cash flow from financing activities is about inflows and outflows of cash related to funding your company. If you got a new loan or equity investment, or similarly if you paid down debt or bought back some stocks, then you’d find these activities listed under this section of the cash flow statement.

Learn more about cash flow from investing in our guide

So, while all of these activities bring cash into your bank account (or suck cash out of it), they aren’t related to your daily business operations.

We calculate operating cash flow so we can understand financial health specifically as it relates to the core, day-to-day operations of our business.

Related: Incremental Cash Flow

The Difference Between OCF and Net Income

Operating cash flow and net income are occasionally mistaken for synonyms, though they are, in fact, distinct metrics.

For that reason, let’s quickly highlight the difference.

Net income is what is left over from your sales revenue after subtracting all expenses, such as cost of goods sold, taxes, and interest payments.

It is a measure of profitability.

Operating cash flow is not a measure of profitability in and of itself because it doesn’t take into account expenses related to financing and taxes (see cash flow break-even point).

It is strictly the amount of cash left over from revenue from your core business activities after accounting for the expenses directly related to those activities.

How To Calculate Operating Cash Flow

There are two commonly used ways to calculate operating cash flow:

1. Direct method
2. Indirect method

Which you choose will depend on your goals as well as the financial statements and reports you have at hand.

The direct method is obviously the easiest (it’s kind of in the name).

You add up all cash inflows (like payments received from customers) and all cash outflows (like payments to suppliers) and subtract the outs from the ins.

So, the direct method formula for calculating operating cash flow looks like this:

Operating cash flow = Total cash inflows – Total cash outflows

Told you it was easy.

Then, we have the indirect method.

Despite being slower and more complex, it’s used more often. That’s because most companies stick to the three-statement model of financial reporting, which facilitates the calculation of OCF using the indirect method.

Here’s what it looks like:

You start with net income as your base, taken from the income statement.

Then, you add depreciation and amortization (because these are non-cash expenses accounted for in net income) and subtract the increase in net working capital for the period.

So, the indirect operating cash flow formula looks like this:

Operating cash flow = Net income + depreciation and amortization – increase in net working capital

What Operating Cash Flow Tells You About Your Company’s Financial Health

Operating cash flow tells you about your company’s ability to generate cash from its core activities without those being distorted by one-off cash transactions like debt financing.

First, you want to see whether operating cash flow is positive. If it is, it’s a good sign that your business is generating a return from its primary ongoing activities.

Then, you want to analyze OCF over time. Is the figure trending upwards? This is a good sign that business growth is driving more cash from day-to-day operations.

Lastly, you should compare your operating cash flow with your net income.

If OCF is consistently higher than net income, then investors typically consider that your quality of earnings is high. This means that you’re making the most of your income from normal operations, some of which is then being reinvested in future growth.

Negative vs. Positive Net Cash Flow

One final note when monitoring and measuring cash flow is that while we generally want figures to be positive, a negative operating cash flow metric isn’t automatically a bad thing.

If your operating cash flow is looking strong, but your net cash flow (after accounting for investing and financing activities) is in the negative, this could simply be because you’ve been investing heavily in capital expenditure or stock buybacks.

Most investors and business analysts would see this as a positive thing.

On the flip side, if net cash flow is positive but is propped up by loans or stock selloffs, and your operating cash flow itself is negative, this might be a bad sign that your business isn’t able to generate significant cash from its primary activities.

So, negative net cash flow isn’t necessarily a bad thing, but negative operating cash flow almost always is (the exception being in the case of pre-revenue early-stage startups, but we’ll save that story for another day).

Track Operating Cash Flow In Finmark

Like many finance metrics, operating cash flow is incredibly important to track but can be cumbersome to calculate.

OCF tells you how much cash your company is throwing off from its core business activities, so it’s obviously something you want to keep a close eye on.

But having to run through the operating cash flow formula each time you want an up-to-date figure is, to be frank, just a bit of a waste of time.

That’s why the best finance leaders use a financial reporting and planning platform like Finmark from BILL to automate away their report creation.

With Finmark, you can view OCF whenever you need, without having to run through complex formulas directly in the context of your cash flow statement.

Check it out for yourself with a 30-day free trial.