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Top 5 operating cash flow FAQs answered

Capitalise Mar 28, 2024

Operating cash flow (OCF) is the cash flow your business generates from daily operations – in other words, the money you make from the goods you sell or the services you offer. 

This operating cash flow definition sounds simple, but understanding how operating cash flow differs from other, seemingly similar cash flow concepts can get confusing. In this article, we’ll clear up the following:

  1. What is operating cash flow? 
  2. How do you calculate operating cash flow?
  3. Is operating cash flow the same as EBITDA?
  4. What’s the difference between operating cash flow and free cash flow?
  5. What does positive operating cash flow mean?

What is operating cash flow?

 You can find your operating cash flow in the ‘operating activities’ section of your cash flow statement. It might be listed as operating cash flow (OCF) or as cash flow from operations (CFO). The only difference between OCF and CFO is the name – they’re simply two separate terms that refer to the same thing.

Your cash flow statement also includes sections for ‘investing activities’ and ‘financing activities’, but neither of these are factored into your operating cash flow.

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. 

 

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.

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:

  • Net income: You can find this on your income statement and is calculated on an accrual basis by subtracting expenses, interest and tax from your revenue.
  • Non-cash expenses: These are the items listed on your income statement that don’t involve cash payment, for example depreciation and amortisation.
  • Working capital: Found on your balance sheet, this refers to your current assets minus current liabilities; working capital changes to look out include inventory as well accounts payable and receivable.

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. 

Is operating cash flow the same as EBITDA?

The short answer is no, operating cash flow is not the same as EBITDA (Earnings before Interest, Taxes and Amortisation). 

The key difference is that both the direct and indirect method for calculating operating cash flow takes taxes and interest into account. In addition, the indirect method of calculating operating cash flow also takes depreciation and amortisation into account. As the name suggests, EBITDA doesn’t account for any of these factors.

What’s the difference between operating cash flow and free cash flow?

The simplest way to illustrate the difference between operating cash flow and free cash flow is to look at the formula used to calculate free cash flow:

Free Cash Flow = Operating Cash Flow - Capital Expenditure

So, free cash flow is calculated by subtracting your capital expenditure from your operating cash flow. Capital expenditure is listed under “investing activities” on your cash flow statement and refers to the money you invest in upgrading, maintaining or acquiring long-term assets essential for the running of your business. These assets might include buildings, equipment, machinery, software and vehicles.

What does positive operating cash flow mean?

Having positive operating cash flow is a good indication that your business is generating enough cash to cover your operating expenses. On the flip side, negative operating cash flow is a sign that your business might need funding to cover day-to-day costs such as salaries, supplier payments or rent and utilities.

Capitalise works with over 100 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. Simply start a funding search to find the best fit for your business.

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