What is operating cash flow?

This article is for educational purposes and does not constitute financial, legal, or tax advice. For specific advice applicable to your business, please contact a professional.

Operating cash flow (OCF) is one of three types of cash flow that are important for business owners to track. OCF refers to the cash generated by your business as you go about your day-to-day operations. It is the first line item that is entered on your cash flow statement, along with income from investment and financing activities.

It describes the cash that needs to be on hand to cover the company’s current liabilities and ensures you are able to operate without relying on borrowing.
Calculating your OCF helps you to determine the cash impact your normal operating activities have on your net income.

When your company is able to keep its operating cash flow positive, it can invest in capital expenditures (CAPEX) and other activities that can fuel its growth. Without a healthy OCF, you will have to finance growth by borrowing. The repayments and interest rates of which may place a squeeze on future profits.

Operating cash flow formula

There are two ways of presenting a company’s OCF. Each uses a different calculation to achieve the same figures.

The first is by using the indirect method. This is where the company’s net income is adjusted to a cash basis using changes in non-cash accounts. These include accounts receivable, accounts payable, and depreciation. This is the method most commonly used since most companies use the accrual method of accounting. As such, net income includes non-cash accounts like depreciation and amortisation.

However, companies that account for their income on a cash basis can calculate their operating cash flow using the direct method.

Here, information is displayed using the actual cash inflows and outflows for a given accounting period. Presentation will typically include:

• employee salaries
• cash payments to suppliers
• cash collected from customer payments
• income from interest and dividends received
• interest and income tax payments made

Operating cash flow vs free cash flow

Operating cash flow and free cash flow share some similarities. However, it’s easy to get into the habit of using the two terms interchangeably. Free cash flow refers to the money left over after capital expenses, interest expenses and allowances have been deducted. It is calculated by deducting these from the company’s OCF.

Alternatively, free cash flow can be calculated by deducting interest, CAPEX, income taxes, amortisation, depreciation and other changes in working capital from pre-tax earnings.

Learn more about how cash flow statements can help you take control of your business finances.

Frequently asked questions about operating cash flow

Why is it important to calculate operating cash flow?

Operating cash flow is a useful metric for both business owners and external analysts to track. Quite simply, it helps to determine how efficiently the company’s current operations generate revenue. High earnings can be misleading, especially if a company historically struggled to receive payment for goods or services sold. Likewise, accelerated depreciation and an abundance of fixed assets can generate a high OCF from a relatively low net income.

What are the different types of cash flow?

Businesses have three types of cash flow: operating, investing, and financing.

Operating cash flow accounts for the cash generated by the company’s primary operational activities. Investing cash flow accounts for the company’s capital assets and investments. Financing cash flow includes the money it makes from issuing debt or equity, or payments made by the company for the same.

How can I improve my company’s operating cash flow?

If you feel that your operating cash flow is negatively proportionate to your income, it can be improved by:

• negotiating faster payment terms with clients
• incentivizing early repayment
• enforcing penalties for late payment
• leasing machinery and plant instead of buying it
• keeping a watchful eye on areas of wasteful spending