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 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)., 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 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.. 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 addedNon-cash Items Are AddedNon-cash expenses are those expenses recorded in the firm's income statement for the period under consideration; such costs are not paid or dealt with in cash by the firm. It involves expenses such as depreciation. like depreciation, Stock-based compensationStock-based CompensationStock-based compensation also called share-based compensation refers to the rewards given by the company to its employees by way of giving them the equity ownership rights in the company with the motive of aligning the interest of the management, shareholders and the employees of the company., other expense or other income, deferred taxes.
- Changes in working capital adjustment that includes inventory account receivable and unearned revenueUnearned RevenueUnearned revenue is the advance payment received by the firm for goods or services that have yet to be delivered. In other words, it comprises the amount received for the goods delivery that will take place at a future date.;
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. + 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.
- DepreciationDepreciationDepreciation 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. 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 lossesUnrealized Gains Or LossesUnrealized Gains or Losses refer to the increase or decrease respectively in the paper value of the company's different assets, even when these assets are not yet sold. Once the assets are sold, the company realizes the gains or losses resulting from such disposal..
- Deferred Tax is a difference in tax which the company paid and its financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels..
- 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 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. 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.
|Operating Cash Flow (OCF)||?|
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 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. $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. through indirect method will be as follows:-
In below template is the data for the calculation of Operating Cash Flow Equation.
|Non- Cash Expense||$200|
|Changes in Operating Assets and Liabilities|
|Operating Cash Flow (OCF)||?|
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 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., 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 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. .
- 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 –