Operating cash flow is the term used to describe the cash generated due to your company’s activities and operations. If you want to calculate it using the indirect technique, you should start with your net income and add depreciation and changes in receivables and inventories.
Start with your gross income if you want to calculate it using the direct method. Most companies and investors choose this method over the direct method, which details the incoming and outgoing transactions of a bank account.
But How Do You Calculate Cash Flow From Indirect Method?
Most companies compile their financial statements using the accrual method, which requires them to display new income when produced rather than when they get money for it.
These financial transactions are reorganised in the cash flow statement to reflect how cash is moved rather than the time when income or costs are officially recognised. This is because the cash flow statement focuses on how money is moved.
When calculating cash flow using the indirect method, the value of the net income, also known as the net profit, at the end of the reporting period is used as the starting point. After that, you make the necessary adjustments to this value of net income based on the numbers that are included inside the balance sheet, and you remove the impact of any non-cash movements that are shown on the profit and loss statement.
There are five processes involved in calculating the indirect operational cash flow, and they are as follows:
- Net Income: Calculate your net income, which may be thought of as a straightforward measurement of your revenues after they have been subtracted from your costs, interest, and taxes. You may determine this by examining the statistics for accrual net income that are included on your income statement.
- Expenditures: These may include items like depreciation, amortisation, or prepaid costs, among other things. Add back in all your costs paid for using a method other than cash.
- Working Capital: What we mean when talking about “working capital” is the money we have available to pay our immediate and short-term financial commitments. It is calculated by subtracting your current obligations from your existing assets. Examine your accounts receivable, inventories, payable, and any other shifts in your working capital. This might help you understand how big of a difference there is between your net income and your cash flow.
- Other Non-Cash Expenditures or Client Deposits: Include any customer deposits or non-cash expenses you did not account for on your income statement. Also, include any other non-cash expenses that you incurred.
- Operating Cash Flow: This is where things start to get complex. Apply the recipe, and then combine all of the ingredients. Take your accrued net income plus depreciation and then remove your change in accounts receivable, change in inventory, and change in accounts payable. This will give you your net change in financial position. After that, add any expenditures not paid in cash and deduct any deposits made by customers.