What is the Operating Cash Flow Formula?

Operating cash flow (OCF) is the measurement of cash generated by a business’s normal operating activities during a time period. OCF is found by adding back non-cash items to net income and adjusting for changes in net working capital. 

What is the operating cash flow formula?

There are two formulas used for calculating operating cash flow. One is simplified, and the other adds extra details.

The simple operating cash flow formula is:

Operating cash flow (OCF) = net income + non cash expenses - increase in working capital

The detailed operating cash flow formula is:

Operating cash flow = net income + depreciation + stock based compensation + deferred tax + other non cash items - increase in accounts receivable - increase in inventory + increase in accounts payable + increase in accrued expenses + increase in deferred revenue

The formula may slightly vary from business to business. It’s important to account for all variables in the operating activities section of the statement of cash flows.

What is the direct method of operating cash flow?

Operating cash flow can be presented in a direct or indirect method on the cash flow statement. The direct method takes all the transactions on a cash basis and uses cash outflows and inflows. Some examples of operating cash flow variables using the direct method include:

  • Interest paid
  • Income tax
  • Employee salaries
  • Cash paid to suppliers
  • Cash received from customers
  • Interest income
  • Dividends received

What is the indirect method of operating cash flow?

The indirect method starts with the net income on an income statement and adds non cash items. Let’s look at an example of the indirect method below.

A company has a net income of $10M, a depreciation of $15M, a decrease in accounts payable of $5M, and an increase in accounts receivable of $5M. The operating cash flow would be $15M. The operating cash flow section would show:

  • Net Income: $10M
  • Depreciation: +$15M
  • Accounts Receivable Increase: -$5M
  • Accounts Receivable Decrease: -$5M
  • OCF: $15M

Why is operating cash flow important?

Operating cash flow is important because it lets people understand how a company is currently operating. If a company’s operating cash flow is low, it knows it’s time to reach out to investors or start financing to bring in external funding. This is a temporary fix, and having a sustainable operating cash flow is crucial for long term success. 

What are the 3 types of cash flows?

The 3 types of cash flows are:

  • Operating cash flows that cover the cash generated from the main business activities.
  • Investing cash flows made up of investments in business ventures and purchases of capital assets.
  • Financing cash flows, which can include payments made by a company and cash inflows from issuing debt.

Operating cash flow measures the cash generated from a business’s normal operating activities. You can calculate it by adding non cash expenses to net income and subtracting increase in working capital.

It can be shown on the statement of cash flows using the direct method or indirect method. The two other types of cash flows are investing and financing.