Cash flow from operating activities is a part of a company’s cash flow statement that provides the information of the total income generated by a company from ongoing business activities, it’s sources and uses. It is abbreviated as CFO and typically entails the details of the net income from the income statement, net income adjustments and changes made to the working capital.
CFO is also known as operating cash flow and is the first section presented on a company’s cash flow statement. Here, we have explained in and out of CFO including the examples, format and importance.
As mentioned, usually, any organization’s cash flow statement depicts its cash flow from operating activities in its first section. This practice is followed by Chartered Accountants and auditors worldwide.
Note that CFO excludes three crucial sectors of a business’s finances:
CFO is the undisputed marker of a company’s liquidity and financial strength. It measures how much money (notionally referred to as ‘cash’ here) has entered the firm’s corpus and how much has exited.
It measures the current market situation of that firm’s primary products and services, to give just two examples.
It reflects the following metrics in detail:
Any company must keep detailed records of their financial activities. These records are mostly made public when quarterly or annual reports are released. Since CFO apportions voluminous information on profits, losses, operational activities, and a brief digest of overall corporate efficiency, computing it is crucial.
Here are three reasons why accountants and C-Suites alike lay great stress on CFO:
There are several misconceptions and misinterpretations related to these two terms. Their chief differences are the following:
|CFO (or OCF)||Net income|
|Comprises only of cash inflow and outflow. Non-cash expenses are not included.||Includes non-cash expenses and upheavals in working expenditure.|
|CFO does not factor in amortisation or share-based compensation.||Net income takes into account amortisation and any share-bound or share-based compensation.|
|Companies may have positive cash flow from operating activities while also having a negative net income.||Almost every company which has a negative net income but a positive CFO has failed. It is not viable.|
|CFO only deals with core businesses or interests. Any external factor has no impact.||When calculating Net Income, any profits/losses from non-core businesses are considered. This results in a consolidated income statement.|
There are two formats to determine this type of cash flow – direct and indirect.
Of these, the indirect method is preferred as it uses the ‘accrual method of accounting’. The calculation starts with the net income and then works backwards using this accrual method. Finally, the CFO for a particular period is computed.
The direct method is a bit complicated. As is obvious, such an organisation monitors and notes the inflow and outflow of cash on a regular basis. Salaries and wages, interests and dividends, (whether paid or collected) and miscellaneous cash transactions are recorded in this method.
Both of these methods have differing formulae for precise calculation.
They have been tabulated below.
|Formula to calculate cash flow from operating activities direct method||
|Note: This formula is based on a single FY only. Overlapping FYs and subsequent calculations will have errors.|
The second method is the following.
|Formula to calculate cash flow from operating activities indirect method||The ‘shorter’ formula is:
Some real-life examples of CFO are – Godrej or Usha Lexus specialises in manufacturing furniture, Cognizant and TCS deliver IT/ITeS services and Deloitte and PWC are involved in business consulting.
Note that both direct and indirect formulas yield identical results.
Let us take Apple Inc.’s financial statements for FY 2017-2018. In that year, this giant corporation had the highest income in almost 10 years.
These reports are available on their official website.
Following the direct method,
Upon careful calculation, cash flow from operating activities was $77.43 billion for FY 2017-2018.
Following the indirect method,
Using the indirect method formula, the CFO was the same – $77.43 billion.
Hopefully, it is now clear why precisely calculating cash flow from operating activities is essential for businesses large and small. Note that CFO is not the last word on many corporate decisions. At times, a company’s Board of Directors (BoD) may overturn any decisions arrived from judging CFO.
One such example is Netflix. Even three years ago, it had modest revenues but very humble profits. Their management stood fast, however, despite advice from financial experts. Now, Netflix is a household name.