What Is Operating Cash Flow?

Operating cash flow is cash generated from the normal operating processes of a business. A company's ability to generate positive cash flows consistently from its daily business operations is highly valued by investors. In particular, 澳洲幸运5官方开奖结果体彩网:operating cash flow can uncover a company's true profitability. It’s one of the purest measures 🐽of cash sources and uses, so let's dive into reviewing ca꧃sh flow from operations via the cash flow statement.

The Cash Flow Statement

Operating cash flow can be found in the cash flow statement, which reports the changes in cash compared to its static counterparts—the income statement, balance sheet, and 澳洲幸运5官方开奖结果体彩网:shareholders’ equity statement. Also known as the cash flow from operations (CFO), it specifically reports w༒here cash is used and generated overಌ specific time periods, tying the static statements together.

By taking net income on the income statement and making adjustments to reflect changes in the 澳洲幸运5官方开奖结果体彩网:working capital accounts on the balance sheet 🅺(receivables, payables, inventories) and other non-cash charges, the operating cash flow section shows how cash was generated during the period. It is this translation proc🌳ess from accrual accounting to cash accounting that makes the operating cash flow statement so important.

The cash flow statement is broken down i🌺nto three categories. These are segregated so that analysts develop a clear idea of all the cash flows generated by a company’s vario🍸us activities:

• Cash flow from operating activities: This category records a company's operating cash movement, the net of which is where operating cash flow is derived.
• Cash flow from investing activities: This category records changes in cash from the purchase or sale of property, plants, equipment (PP&E), or long-term investments.
• Cash flow from financing activities: This category reports cash level changes from the purchase of a company’s own stock or issue of bonds and payments of interest and dividends to shareholders.

In some cases, there is a s𓄧upplemental activities category as well. Supplemental information refers to anything else that does not relate to the other major categories.

Breakdown of Activities

Operating activities are normal and co༺re 🌼activities within a business that generate cash inflows and outflows. They include:

• Total sales of goods and services collected during a period
• Payments made to suppliers of goods and services used in production settled during a period
• Payments to employees or other expenses made during a period

Cash flow from operating activities is anything it receives from its operations. This means it excludes money spent on capital expenditures, cash directed to long-term investments, and any cash received from the sale of 澳洲幸运5官方开奖结果体彩网:long-term assets. Also excluded are the amounts paid out as dividends to stockholders, amounts received through the issuance of bonds and stock, and money us⛦ed to redeem bonds.

Investing activities consist of payments made to purchase long-term assets, as well as cash received from the sale of long-term assets. Examples of investing activities are the purchase or sale of a 澳洲幸运5官方开奖结果体彩网:fixed asset or property,꧅ plant, and equipment, and the purchase o𒁃r sale of a security issued by another entity.

Financing activities consist of activities that will alter the equity or borrowings of a company. Examples of financing activities include the sale of a company's shares or the 澳洲幸运5官方开奖结果体彩网:repurchase of its shares.

Calculating Cash Flow

To see the importance of changes in operating cash flows, it’s important to understand how cash flow is calculated. Two methods are used to calculate cash flow from operating activities, both 🍬of which produce the same result:

• Direct method: This method draws data from the income statement using cash receipts and cash disbursements from operating activities. The net of the two values is the operating cash flow.
• Indirect method: This method starts with 澳洲幸运5官方开奖结果体彩网:net income and converts it to OCF by adjusting for items that were used to calculate net income but did not affect cash.

Direct Method

The 澳洲幸运5官方开奖结果体彩网:direct method adds up all the various types of cash payments and receipts, including cash paid to suppliers, cash receipts from customers and cash paid out in salaries. These figures are calculated by using the beginning and ending balances of a variety of business ac♏counts and examining the net decrease or increase of the account.

The exact formula used to calculate the inflows and outflows of the various accounts differs based on the type of account. In the most commonly used formulas, 澳洲幸运5官方开奖结果体彩网:accounts receivables are used on🔯ly for c꧟redit sales, and all sales are done on credit.

If cash sales also occur, receipts from cash sales must also be included to develop an accurate figure of cash flow from operating activities. Since the direct method does not include net income, it must also provide a 澳洲幸运5官方开奖结果体彩网:reconciliation of net income to the net cash provided by operatio๊ns.

Indirect Method

Under the 澳洲幸运5官方开奖结果体彩网:indirect method, cash flow from operating activities is calculated by first taking the net income from a company's income statement. Because a company’s income statement is prepared on an 澳洲幸运5官方开奖结果体彩网:accrual basis, revenue is only recognized when i🌄t is earned and not when it🥂 is received.

Net income is not a perfectly accurate representation of net cash flow from operating activities, so it becomes necessary to adjust 澳洲幸运5官方开奖结果体彩网:earnings before interest and𒁃 taxes (EBIT) for items that affect net income even though no actual cash has yet been received or paid against them. The indirect m𝓰et💜hod also makes adjustments to add back non-operating activities that do not affect a company's operating cash flow.

Which Method Should You Use?

The direct method for calculating a company's cash flow from operating activities is a more straightforward approach in that it reveals a company's operating cash receipts and payments, but it is more challenging to prepare since the information is difficult to assemble. Still, whether you use the direct or indirect method for calculating cash from operations, the same result will be produced.

Operating Cash Flows (OCF)

OC൩F is a prized measurement tool as it helps investors gauge what’s going on behind the scenes. For many investors and analysts, OCF is considered the cash version of net income, since it cleans the income statement of non-cash items and non-cash expenditures (depreciation, amortization, non-cash working capit💙al items).

OCF is a more important gauge of profitability than net income as there is less opportunity to manipulate OCF to appear more or less profitable. With the passing of strict rules and regulations on how overly creative a company can be with its accounting practices, chronic 澳洲幸运5官方开奖结果体彩网:earnings manipulation can easily be spotted, especially with the use of OCF. It is also a good proxy of a company’s net ꦚincome. For instance, a reported OCF higher than NI is considered positive as income is understated due to the reduction of non-cash items.

Positive/Negative Cash Flow From Operations

A positive CFO means the company is bringing in more cash from selling goods or services than it is spending on operational expenses. A negative CFO suggests that a company is sp👍ending more cash on operations than it is generating.

It's worth calling out that a negative cash flow from operations is not always a red flag. It's probably assumed that 澳洲幸运5官方开奖结果体彩网:start-ups or strong-growth companies will have neg♔ative operational cash flow. The true value of understanding operational cash flow is to evaluate it over time to see if a company is continually struggling.

The implications of positive or negative CFO also depend on industry norms and company-specific circumstances. For example, 澳洲幸运5官方开奖结果体彩网:seasonal businesses may experience temporar💛y negative CFO during slow periods but generate strong cash flows during peak seasons. Similarly, a tech startup investing heavily in product development may report negative CFO initially, but that investment should hopefully produce positive cash flow in the future.

The Bottom Line

Operating cash flow is just one component of a company’s cash flow story, but it is also one of the most valuable measures of strength, profitability, and the long-term future outlook. It is derived either directly or indirectly and measures money flow in aꦦnd out of a company over specific periods.

Unlike net income, OCF excludes non-cash items like depreciation and amortization, which can misrepresent a company's actual financial position. It is a good sign when a company has strong operating cash flows with more cash coming in than going out. Companies with strong growth in OCF most likely have a more stable net income, better abilities to pay and 澳洲幸运5官方开奖结果体彩网:increase dividends, and more opportunities to e♔xpand and weather downturns in the genꦏeral economy or their industry.

If you think cash is ki⭕ng, strong cash flow from operations is what you should watch for wh♊en analyzing a company.