Operating cash flow should be the sole monetary indicator that you monitor about your company if you are only going to do so for a single metric. The operating cash flow of your company provides a bird’s eye perspective of the economic status of your firm and can forecast the success or failure of your business in the future.
The data for your cash flow will tell whether or not your company is in good health and able to create enough money to pay your bills, continue to operate, and develop, or whether or not it is in crisis and needs more funding from outside sources to stay afloat. To protect your company against the possibility of going bankrupt, your operational cash inflow has to be greater than your cash outflow.
So, you need to learn how to calculate Operating Cash Flow (OCF) for getting a better picture of your company’s profit and loss!
Operating Cash Flow Definition
A company’s Operating Cash Flow (OCF) is the total amount of cash that it generates through its day-to-day business operations over a certain period. The operating cash flow (OCF) starts with net income, adds back any non-cash items, and then adjusts for changes in net working capital to get at the total cash produced or spent in the period.
When doing financial analysis, Operational Cash Flow should be utilised in combination with net income, Free Cash Flow (FCF), and other indicators to conduct an accurate evaluation of the performance and financial health of a firm.
Read more: Guide To Operating Cash Flow Formula
How To Calculate Operating Cash Flow (OCF)?
It is crucial to know how to calculate the Operating Cash Flow (OCF) regardless of whether you are an accountant, a financial analyst, or a private investor. When we read financial accounts, it’s possible that we don’t always pay close enough attention to how many steps are involved in the computation.
Let’s take a closer look at the Operational Cash Flow formula and the many components that make it up:
Operating Cash Flow = Total Revenue – Operating Expense
There is a possibility that there may be more non-cash items and further changes in current assets or current liabilities that are not included above. The most important thing is to check that every item has a record associated with it; how exactly this is done varies from business to business.
Difference Between Operating Cash Flow & Net Income
Because it takes into account depreciation, receivables, and liabilities, investors and lenders would rather examine your Operational Cash Flow than your net income. This is because the latter does not take these factors into account. Businesses can report positive net profits while simultaneously suffering from a severe lack of cash and being unable to meet their financial obligations.
For example, if merchandise is sold but no cash is brought in at that time, the number of sales may seem to be more than it is. Furthermore, if there were to be goods returns, there would never be any cash received for the inventory in question.
The Operational Cash Flow statistic would expose the genuine picture, while the net income figure would create the illusion that the firm is more lucrative than it is. This is because the net income figure would indicate an inflated sales figure during that time.
When Operational Cash Flow is compared to net income, investors and lenders may determine whether or not accounting practices are being used to manipulate the numbers. For instance, if a corporation declares strong profits but has a low amount of cash on hand, the accounting processes used by the company can be called into question.
This is particularly true if this situation persists over several consecutive quarters. No matter how the figures are manipulated on the net income report, the fact remains that a business will, at some point, need adequate cash to pay its debtors. As a result, unethical business practices will, at some point, become commonplace.
On the opposite end of the spectrum, if your operating cash flow is higher than your net income, this may mean that your company has more cash than is reflected on the net income statement and is healthier than it appears on paper. In other words, if your operating cash flow is higher than your net income, your company is doing better than it seems on paper.
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Importance Of Operating Cash Flow
Cash flow indicators are often used by financial analysts because they eliminate certain accounting irregularities. Operating cash flow, in particular, paints a more accurate picture of the reality of the situation the firm finds itself in at the moment.
A healthy Operational Cash Flow comes with several benefits for the business. The capacity to keep up with your financial obligations and keep your business running smoothly is perhaps the single most crucial factor. You will also be able to weather unexpected setbacks, such as a client going out of business, if you have a good cash flow.
This gives you the ability to tolerate delays in payment from clients. If you have a solid working cash flow, you will have the freedom and the capacity to grow your company whenever you see fit. For brand new pieces of machinery, for instance, you may spend less if you pay cash for them instead of financing them via the vendor.
That you have a strong possibility of securing funding is another implication of this. Underwriters will give the financial accounts of your firm careful consideration while evaluating the loan application that you have submitted. They will see that you are a strong candidate for credit if your Operational Cash Flow is continuously positive. This is because it demonstrates that you have the cash on hand to service your loan.
If a firm is unable to generate a sufficient amount of revenue through its primary business activities, it will be necessary for the company to seek out temporary sources of external finance via financing or investment. On the other hand, this cannot be maintained over an extended period. Because of this, Operational Cash Flow is a crucial metric to consider when evaluating the economic viability of a company’s business activities.