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Operating cash flow is the cash your business generates from its normal day to day trading, before any spending on investments or financing is taken into account. In other words, it is the actual cash coming in and going out from selling your goods or services, running your operations and collecting from customers.
Operating cash flow matters because it tells you whether your core business is generating enough real cash to cover its own running costs, regardless of what your profit figure says. Below, we cover the operating cash flow formula, a worked example, how it compares to net income, EBITDA and free cash flow, and what to do if yours is running low.
What is operating cash flow?
Operating cash flow, sometimes shortened to OCF and also known as cash flow from operations, is the section of your cash flow statement that shows the cash generated purely from running the business. Your full cash flow statement also includes investing activities, such as buying equipment, and financing activities, such as taking out a loan or paying a dividend, but neither of these count toward operating cash flow.
Because it strips out investing and financing activity, operating cash flow gives a cleaner picture of whether your core trading activity is self sustaining. A business can be profitable on paper and still run into trouble if its operating cash flow is weak, since profit is recorded on an accrual basis while operating cash flow only counts cash that has actually moved.How do you calculate operating cash flow?
It’s important to understand that not all businesses use the same formula to calculate operating cash flow. This means that the operating cash flow shown on your cash flow statement will depend on the method used to prepare it.
Operating cash flow formula
Not every business calculates operating cash flow the same way. There are two accepted methods, the direct method and the indirect method, and both should arrive at the same figure.
Method | Formula | Best suited to |
|---|---|---|
Direct method | Operating cash flow = total cash receipts minus total cash payments | Businesses that track cash transactions closely and want a granular view |
Indirect method | Operating cash flow = net income + non cash expenses plus or minus changes in working capital | Most businesses, since it uses figures already in your financial statements |
Direct method operating cash flow formula
The direct method for calculating operational cash flow uses a very simple formula:
Operating Cash Flow = Total Cash Receipts - Total Cash Payments
In this scenario, cash receipts might include cash received from customers and any income earned from dividends or interest during a given period of time. Cash payments could be salaries, any income tax paid during that period, as well as cash payments to suppliers.
While this is a simple calculation, recording every payment and receipt on a cash basis and then listing them on your cash flow statement can be time consuming. The direct method has the benefit of providing you (and any investors) with a granular level of detail but there’s also a greater risk of error if even one cash transaction falls through the cracks.
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Indirect method operating cash flow formula
The other, and more common, way to calculate operating cash flow is the indirect method. This is what the indirect method operating cash flow formula looks like:
Operating Cash Flow = Net Income + Non-Cash Expenses +/- Changes in Working Capital
This method involves taking your net income and then adjusting it for depreciation and amortisation as well as any changes to your assets and liabilities. Here’s a breakdown of the factors to consider:
Although there’s more information feeding into this formula, it’s all readily available in your financial statements which makes the indirect method a more popular choice among busy business owners.
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Worked example: how to calculate operating cash flow
Here is a simple example using the indirect method, which is the version most business owners will recognise from their own accounts.
Line item | Amount |
|---|---|
Net income | £80,000 |
Add back depreciation and amortisation | £15,000 |
Increase in accounts receivable | minus £10,000 |
Decrease in inventory | plus £5,000 |
Increase in accounts payable | plus £8,000 |
Operating cash flow | £98,000 |
In this example, the business made £80,000 in accounting profit but generated £98,000 in actual operating cash. The difference comes from non cash depreciation being added back, and from working capital moving in the business's favour, in this case customers were slower to pay but the business also held less stock and paid suppliers more slowly.
Operating cash flow vs net income
Net income is your accounting profit, calculated by subtracting expenses, interest and tax from revenue on an accrual basis, meaning it counts a sale or a cost when it is recorded, not when the cash actually changes hands. Operating cash flow adjusts that figure for non cash items and timing differences, so it reflects real cash movement instead.
This is why a growing, profitable business can still run short of cash. If customers are slow to pay or stock is building up, net income can look healthy while operating cash flow tells a very different story.
Operating cash flow vs EBITDA
Operating cash flow and EBITDA (earnings before interest, tax, depreciation and amortisation) are often confused, but they are not the same thing. EBITDA is a measure of operating performance that ignores interest, tax, depreciation and amortisation entirely. Operating cash flow, calculated using either method, does account for interest and tax actually paid, and the indirect method also factors in depreciation, amortisation and working capital changes. Read more in our guide to EBITDA.
What’s the difference between operating cash flow and free cash flow?
Free cash flow takes operating cash flow one step further by subtracting capital expenditure, the money spent on buying, upgrading or maintaining long term assets such as equipment, vehicles or premises.
Free cash flow = operating cash flow minus capital expenditure
Operating cash flow shows what your day to day trading generates. Free cash flow shows what is left after you have also paid for the investment needed to keep the business running and growing, which is the cash genuinely available to repay debt, reward shareholders or reinvest elsewhere.
Operating cash flow ratio: what counts as healthy
The operating cash flow ratio measures how comfortably your cash from operations covers your short term obligations. It is calculated by dividing operating cash flow by current liabilities.
Operating cash flow ratio | What it suggests |
|---|---|
Below 1.0 | Operating cash flow does not fully cover current liabilities, worth investigating further |
1.0 to 2.0 | Generally considered a healthy range, operating cash flow covers short term obligations comfortably |
Above 2.0 | Strong cash cover, though it is worth checking whether cash is being used productively |
These are general benchmarks rather than fixed rules, since a healthy ratio can vary by sector and business model.
What does negative operating cash flow mean?
Negative operating cash flow means your core trading activity is using more cash than it brings in, which is different from being unprofitable, though the two often happen together. It is common in fast growing businesses that are investing heavily in stock or staff ahead of revenue catching up, but it can also be an early warning sign of slow paying customers, rising costs or falling sales. If it continues for more than a period or two, it is worth reviewing your cash flow forecast to understand exactly where the gap is coming from.
How to improve operating cash flow
If your operating cash flow needs strengthening, focus on the areas that directly affect cash timing rather than only trying to increase sales:
Need to plug a cash flow gap?
If your operating cash flow shows your business is generating less cash than it needs day to day, cash flow finance can help bridge the gap while you fix the underlying cause. At Capitalise we work with over 130 lenders to help small businesses like yours boost cash flow with finance options ranging from invoice finance and revolving credit facilities, to short term business loans and more. Plus you can check your business credit score, all in one place.
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