Operating Cash Flow (OCF)

Operating cash flow or OCF along with other financial metrics proves effective in measuring the financial standing and proficiency of a company.

By reviewing the same, investors, creditors and firm owners can make an informed decision about the firm and its future.

What is Operating Cash Flow?

Operating cash flow can be simply described as the measure of cash a company generates through its core business operations within a specific time.

It helps to analyze if a company is capable enough to generate the required amount of cash flow to maintain and expand its existing business operations. 

In short, OCF serves as an effective benchmark for determining a company’s financial success concerning its operational activities. 

Operating cash flow generates money through activities, which include –

  • Aggregate sales of goods and services within a given period.
  • Payments to goods and service suppliers.
  • Pay-outs forwarded to employees or other expenses incurred for production.

Notably, operating cash flow is recorded on a cash flow statement right in the first section. Furthermore, it also highlights a clear demarcation between the cash generated through investing activities and financing activities. 

Methods of Operating Cash Flow

Usually, there are two operating cash flow methods, namely –

  • Direct Method

It is regarded to be a simple formula that helps to obtain accurate results. However, this operating cash formula does not provide much insight to potential investors. Resultantly, it is used mostly by companies to track their operational performance. 

The formula is expressed as,

Operating Cash Flow = Total Revenue – Operating Expense

  • Indirect Method

In this method, the net income is adjusted by adding the non-cash items to account for the changes in the balance sheet. On the other hand, depreciation is also added to the net income to adjust the changes in cash receivable and inventory. 

In other words, the indirect method of calculating OCF requires the addition of non-cash items to the net income and also tunes out the changes in the net capital. 

It is further expressed as,

Operating Cash Flow = Net income (+/-) Changes in assets and liabilities + Non-cash expenditure

Operating Cash Flow Formula with Example

Like discussed, the OCF formula can be given by - 

Operating Cash Flow Formula (OCF) = Net Income + Depreciation + Deferred Tax + Stock-oriented Compensation + non-cash items – Increase in Accounts Receivable – Increase in Inventory + Increase in Accounts Payable + Increase in Deferred Revenue + Increase in Accrued Expenses.

or,

OCF = Net Income + Non-cash Expenses – Increase in Working Capital

Operating Cash Flow Example

Joe Limited’s financial statements for the financial year 2017 comprise this following information.

  • Net income: Rs.100000
  • Depreciation: Rs.10000
  • Change in inventory: Rs.20000
  • Change in accounts receivable: Rs.50000
  • Change in accounts payable: Rs.25000

Solution: By using the indirect method of operating cash flow, 

OCF = Net Income (+/-) Changes in Assets and Liabilities + Non Cash Expenses

= Rs.(100000 – 50000 + 20000 – 25000 – 10000)

=Rs.55000

Significance of Operating Cash Flow 

Importance of operating cash flow is as follows –

  • A negative OCF indicates that a company does not have sufficient funds to run its core operations and needs to borrow funds to maintain the same.

  • A relatively high net income may indicate that the firm finds it challenging to collect accounts receivable.

  • It is considered to be among the purest measures of cash sources and offers a transparent insight into a company’s operational performance.

  •  It serves as a gateway to other reported financial statements.

Net Income vs Operating Cash Flow

The basic differences between the two are highlighted in the table below –

Operating Cash Flow

Net Income

It is the cash generated through the core operations of a company.

It is essentially the profit earned within a period.

It serves as a measurement of a company’s daily cash inflow and outflow concerning its operations. 

Net income serves as the starting for computing a company’s operating cash flow.

It serves as a metric of a company’s capability to pay off its debt in the short-term.

It is a crucial measure of a company’s profitability and a driver of bond valuation and stock pricing.

OCF projects a more transparent image of a company’s finances.

In the case of net income, there is room to manipulate the figures.

High operating cash flow indicates a greater cash inflow than outflow.

A company with a positive OCF can still have negative net income.

OCF Formula = Net Income (+/-) Changes in Assets and Liabilities + Non-Cash Expenses

Net Income Formula = Total revenue – Total expenses

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