Operating Cash Flow Formula

Updated on April 9, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Operating Cash Flow (OCF) Formula?

The Operating Cash Flow Formula signifies the cash flow generated from the core operating activities of the business after deducting the operating expenses. It helps in analyzing how strong and sustainable is the business model of the company.

Operating-Cash-Flow-Formula

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Operating cash flow (OCF) measures the cash that a business produces from its principal operation in a specific period. It is also known as cash flow from operations. It is not the same as net income neither EBITDA nor free cash flowFree Cash FlowThe cash flow to the firm or equity after paying off all debts and commitments is referred to as free cash flow (FCF). It measures how much cash a firm makes after deducting its needed working capital and capital expenditures (CAPEX).read more.

Operating Cash Flow Formula Explained

Operating cash flow is an important and fundamental financial metric that shows how much cash flow a business is able to generate from the core operations. It is an indicator that helps analysts and investors understand the financial performance of the business. The information can be found in the cash flow statements.

If the cash generating ability of the business is positive if the resultant operating cash flow calculated is high. It also means the company is able to utilize its assets and reosources is the optimum way and there is very less wastage. The core operations are efficiently managed, and the company is in good financial state.

But on the other hand, a low cash flow from operations calculated using the net operating cash flow formula indicates an opposite situation, where the business operations are not able to generate good cash flow and resources are underutilized or misutilised. If OCF is negative, it means a company has to borrow money to do things, or it may not stay in business, but it may benefit the company in the long term. Thus, net operating cash flow formula provides valuable information regarding the cash generating ability of the entity.

Still, all are used for measurement of performance of a company as net income includes a transaction that did not involve the actual transfer of money like depreciation which is a non-cash expense that is part of net incomeNet IncomeNet income for individuals and businesses refers to the amount of money left after subtracting direct and indirect expenses, taxes, and other deductions from their gross income. The income statement typically mentions it as the last line item, reflecting the profits made by an entity.read more not of OCF.

How To Calculate?

There are two formulas to calculate Operating Cash Flow – one is a direct method, and the other is an indirect method.

#1 – Direct Method (OCF Formula)

This method is very simple and accurate. But as it does not provide much detailed information to the investor, companies use the indirect method of OCF. OCF is equal to Total revenue minus Operating expense.

The formula to calculate OCF using the direct method is as follows –

Operating Cash Flow = Total Revenue – Operating Expense

#2 – Indirect Method (Operating Cash Flow Formula)

The indirect method is adjusted net income from changes in all non-cash accounts on the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more. For example, depreciation is added to net income while adjusting changes in inventory and cash receivable. OCF calculates with net income, adds any non-cash item, and adjusts for changes in net capital. This provides total cash generated

Operating Cash Flow formula using the indirect method can be represented as follows –

Operating Cash Flow = Net Income +/- Changes in Assets Liability + Non-Cash Expenses

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Explanation

Now, let us see the main steps required to calculate free operating cash flow formula.

The full formula of Operating Cash Flow is as follows:-

OCF = Net Income + Depreciation + Stock-Based Compensation + Deferred TaxDeferred TaxDeferred Tax is the effect that occurs in a firm as a result of timing differences between the date when taxes are actually paid to tax authorities by the company and the date when such tax is accrued. Simply put, it is the difference in taxes that arises when taxes due in one of the accounting period are either not paid or overpaid.read more + Other non-cash items – Increase in Account Receivable – Increase in Inventory + Increase in Accounts Payable + Increase in Accrued Expenses + Increase in Deferred Revenue

Components

Let’s analyze the various component of the OCF Formula, which are as follows:-

Hence, in short, the OCF formula is:-

ocf formula3

Thus, all the above requirements of the formula can be found in the financial statements of the business and the dat is taken to make the calculation. This is an important metric for analysts, investors and also the management who can make financial plans and take important financial decisions based of the results obtained.

Examples

Let us understand the concept with the help of some suitable examples.

You can download this Operating Cash Flow Formula Excel Template here – Operating Cash Flow Formula Excel Template

Example #1

Suppose there is a company with a total revenue of $1,200 and an overall operating expenseOverall Operating ExpenseOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more of $700. If one wants to calculate Operating Cash Flow, the Direct method will be used.

In the template below is the data for the calculation of Operating Cash Flow.

ParticularsAmount
Total Revenue$1,200
Operating Expense$700
Operating Cash Flow (OCF)?

So, the calculation of Operating Cash Flow (OCF) will be as –

ocf formula example1.2

i.e. OCF Direct = 1,200 – 700

So, OCF will be –

Operating Cash Flow example1.3

Therefore, OCF = $500

Example #2

Suppose a company has a net income of $756, a non-cash expense of $200, and changes in asset-liability, i.e., inventory is $150, account receivableAccount ReceivableAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more $150. Then, Operating Cash FlowOperating Cash FlowCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more through the indirect method will be as follows:-

The below template is the data for the calculation of the Operating Cash Flow Equation.

ParticularsAmount
Net Income$756
Non- Cash Expense$200
Changes in Operating Assets and Liabilities
Inventory$150
Account Receivable$150
Operating Cash Flow (OCF)?

So, the calculation of Operating Cash Flow (OCF) using the indirect method will be as –

Operating Cash Flow Formula example2.2

i.e. OCF Indirect = 756 + 200 – 150 – 150

So, OCF will be –

Operating Cash Flow example2.3

OCF = $256

GAAP requires a company to use an indirect method to compute the figure as it gives all the necessary information and covers the same.

Example #3

A company named Ozone Pvt. Ltd has financial statements in three sections, i.e., operations activities, finance activitiesFinance ActivitiesThe various transactions that involve the movement of funds between the company and its investors, owners, or creditors in order to achieve long-term growth are referred to as financing activities. Such activities can be analyzed in the financial section of the company's cash flow statement.read more, and investing activities. Below is an operational activity financial statement through which we have to calculate Operating Cash Flow.

operating cash flow example3.1

Now, let’s calculate OCF for different periods using the above-given data.

OCF For 2016

operating cash flow example3.2

OCF2016 = 456 + 4882 + 2541 + 250 + 254 + 86 – 2415 – 1806 + 4358 + 856 + 1351

OCF2016 = $ 10,813

OCF For 2017

operating cash flow example3.3

OCF2017 = 654 + 5001 + 2681 + 300 + 289 + 91 – 2687 – 1948 + 5213 + 956 + 1405

OCF2017 = $ 11,955

OCF For 2018

ocf example3.4

OCF2018 = 789 + 5819 + 3245 + 325 +305 + 99 – 2968 – 2001 + 5974 + 1102 + 1552

OCF2018 = $ 14,241

Hence, we found OCF for a different period of a company.

Calculator

You can use the following calculator for the annual operating cash flow formula.

Total Revenue
Operating Expense
Operating Cash Flow Formula
 

Operating Cash Flow Formula = Total Revenue Operating Expense
0 0 = 0

It may be possible that a company has a higher cash flow than net income. In this scenario, it is possible that a company is generating huge revenue but decreases them with accelerated depreciation on the income statementDepreciation On The Income StatementDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more.

When net income is higher than OCF, it may be possible that they have a difficult time collecting receivables from the customer. As depreciation is added to the annual operating cash flow formula depreciation does not affect OCF.

Investors should choose a company with high or improving OCF but low share prices. A company can face loss or small profit due to large depreciation. However, it can have a strong cash flow since depreciation is an accounting expense but not in cash form.

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