Formula to Calculate Operating Cash Flow (OCF)
Operating Cash Flow Formula signifies the cash flow generated from the core operating activities of the business after deducting the operating expenses and helps in analyzing how strong and sustainable is the business model of the company.
Operating cash flow (OCF) is a measure of the cash that a business produces from its principal operation in a specific time period. It is also known as cash flow from operations. It is not the same as net income neither EBITDA nor free cash flow, but 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 income not of OCF.
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, therefore 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 –
#2 – Indirect Method (Operating Cash Flow Formula)
The indirect method is adjusted net income from changes in all non-cash accounts on the balance sheet. Depreciation is added to net income while adjusting changes in inventory and cash receivable. And 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 –
Now, let us see what the main steps required to calculate the Operating Cash Flow are.
- Net income considered as starting point.
- All non-cash items are added like depreciation, Stock-based compensation, other expense or other income, deferred taxes.
- Changes in working capital adjustment that includes inventory account receivable and unearned revenue;
The full formula of Operating Cash Flow is as follows:-
OCF = Net Income + Depreciation + Stock-Based Compensation + Deferred Tax + Other non-cash items – Increase in Account Receivable – Increase in Inventory + Increase in Accounts Payable + Increase in Accrued Expenses + Increase in Deferred Revenue
Let’s analyze the various component of the OCF Formula, which are as follows:-
- Net income is base income, it is a requirement.
- Depreciation helps to account for expensing property, plant, machinery, etc.
- The payment of Stock-based compensation is in non-cash form like in the form of shares.
- Other expense/income includes unrealized gains or losses.
- Deferred Tax is a difference in tax which the company paid and its financial statements.
- Inventory is reduced in an OCF as inventory increase leads to a decrease in cash.
- Accounts receivable is subtracted as an increase in account receivable reduces the cash, which means that the amount is not paid by a customer.
Hence, in short, the OCF formula is:-
Practical Examples of Calculating Operating Cash Flow
Suppose there is a company with total revenue of $1,200 and an overall operating expense of $700, and now, if one wants to calculate Operating Cash Flow, then the Direct method will be used.
In below template is the data for the calculation of Operating Cash Flow.
So, the calculation of Operating Cash Flow (OCF) will be as –
i.e. OCF Direct = 1,200 – 700
So, OCF will be –
Therefore, OCF = $500
Now, 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 receivable $150. Then, Operating Cash Flow through indirect method will be as follows:-
In below template is the data for the calculation of Operating Cash Flow Equation.
So, the calculation of Operating Cash Flow (OCF) using the indirect method will be as –
i.e. OCF Indirect = 756 + 200 – 150 – 150
So, OCF will be –
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.
A company named Ozone Pvt. Ltd has financial statements into three sections i.e., operations activities, finance activities, and investing activities. Below is an operational activity financial statement, through which we have to calculate Operating Cash Flow.
Now, let’s calculate OCF for different periods using the above-given data.
OCF For 2016
OCF2016 = 456 + 4882 + 2541 + 250 + 254 + 86 – 2415 – 1806 + 4358 + 856 + 1351
OCF2016 = $ 10,813
OCF For 2017
OCF2017 = 654 + 5001 + 2681 + 300 + 289 + 91 – 2687 – 1948 + 5213 + 956 + 1405
OCF2017 = $ 11,955
OCF For 2017
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.
Things to Remember
- 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 possibly in a long term company get a benefit.
- It may be possible that a company has a high cash flow than net income. In this scenario, it is possible that a company is generating huge revenue but decrease them with accelerated depreciation on the income statement.
- When net income is high than OCF, it may be possible that they have a difficult time collecting receivable from the customer. As depreciation as added in OCF formula, depreciation does not affect OCF.
- Investors should choose a company that has high or improving OCF but low share prices. A company can face loss or small profit in a period because of large depreciation. However, it can have a strong cash flow since depreciation is an accounting expense but not in cash form.
Operating Cash Flow Calculator
You can use the following calculator for the calculation of Operating Cash Flow.
|Operating Cash Flow Formula =||Total Revenue – Operating Expense|
|0 – 0 =||0|
This has been a guide to Operating Cash Flow Formula (OCF). Here we learn how to calculate cash flow from operations using two formulas (Direct & Indirect Method) along with practical examples downloadable excel template and calculator. You can learn more about financial analysis from the following articles –