Operating Cash Flow

Meaning of Operating Cash Flow

Operating Cash Flow (OCF) is a metric used to test the company’s cash inflow through business. It shows how well a company can produce positive cash flow to support its own business operations. The usage of operating cash flow focuses on maintenance and growth of the core business activities.

For example: manufacturing companies constantly need repairs and upgrades in machinery and technology to become more efficient and maximize their output.

Description of Operating Cash Flow

The metric operating cash flow as seen in the annual or quarterly Cash Flow Statement of a company can be described as the cash version of net income. Working capital (current assets minus current liabilities) such as short term debt accounts receivable and payable and changes in inventory are a part of Cash flow from operating activities. The income generated from activities other than core business is noted separately.Operating Cash Flow

The accountants, investors and members of a company can compare the Operating Cash Flow with the EBITDA to understand its ability to finance short term capital. Investors can find out where exactly a company earns from by separating the operating cash from the cash flow from investments and financing activities respectively.

A positive operating cash flow is favorable as it signals that a company is using its cash resources well. Without a positive OCF, a company may need to borrow funds from outsiders or even wind up business in extreme cases. But having a negative Operating cash flow is not always something to worry about. In cases where a company possesses negative cash flow because it are underway a new plant construction, then it may earn returns with the future operations of the new plant.

Operating Cash Flow Formula

The Operating Cash Flow is calculated using the formula as shown below:

Operating Cash Flow = EBIT (+/–) Changes in Working Capital + Depreciation (non-cash expenses) – Taxes

Where:

Changes in Working Capital = Current Assets – Current Liabilities

Example

Consider the Extract of the Cash Flow Statement of Company XYZ for the year 2016-2017 as given below:

(All figures mentioned are in Million USD)

Particulars Year 2015-16 Year 2016-17
(A) Cash Flow from Operating Activities
EBIT 1000 1500
Add: Depreciation 100 100
Less: Tax (30% of EBIT) (300) (450)
Net Cash generated from Operating Activities $800 $1150

Conclusion

Operating cash flow matters because a positive metric helps the company expand their operations, develop new technologies and products, increase their yield and productivity, reduce debts and even buy back stocks. Dividend payments are affected by cash flow, as it determines the ability to pay. Hence, investors value operating cash flow and look for companies that have a high or improving operating cash flow but low per share rate. This trend often means that the share price of the company will increase soon in the near future.

References:

Last updated on : August 31st, 2018

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