What Is Operating Cash Flow?

By Indeed Editorial Team

Updated February 22, 2021

Published February 4, 2020

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Operating cash flow is a cash value accountants calculate to determine how much money a company has to invest in operations. It's an important measure of how a company is doing financially. When positive operating cash flow exists, business leaders and stakeholders can invest in infrastructure and resources that make working conditions more efficient and scale for additional growth. In this article, we'll tell you about operating cash flow and why it's important.

What is operating cash flow?

When businesses generate spendable cash from regular business activities, the measure of this figure is called operating cash flow. When in the positive, it's indicated that the company has positive cash flow to fund business activities. Without operating cash flow, businesses must seek capital to make investments in their own success from other sources like investors and lenders.

Sometimes called "cash flow from operating expenses," it's a value that appears at the top of a balance sheet and indicates cash brought in from regular business duties, like manufacturing or selling products, or providing a service to customers. This insight serves as a foundational metric that indicates the financial success and security of a company.

Operating cash flow (OCF) appears on a document called a cash flow statement that displays the in-flow and out-flow of all cash in a business. The cash flow statement is usually a combination of information taken from balance sheets and income statements and can be presented either directly or indirectly, as described in more detail below. A cash flow statement is a report document that displays how well a company manages cash, based on the amount of cash and cash equivalents the company has coming and going.

Why is operating cash flow important?

Financial analysts use operating cash flow as a means of determining the real financial health of a business. It's a strong measure because it isn't generally influenced by one-off anomalies. For this reason, it's useful for offering a clear picture of financial standing.

For example, a large boost in revenue from a big booking could temporarily inflate some numbers and make the company seem more successful. Similarly, a surplus in operating cash flow without a high net revenue could indicate other issues, like a balance sheet that has accelerated depreciation calculations and multiple fixed assets. This is financial data the company can use to make business decisions that change how they are positioned in the marketplace.

Finally, using this information can provide insight for business leaders as to what innovation, infrastructure and new resources they can afford without borrowing money. Operating cash flow helps businesses compete better by allowing them to make advances that propel them forward in the marketplace.

Related: 5-Step Strategic Management

How to present operating cash flow

There are two primary methods for presenting operating cash flow on a cash flow statement. They are direct and indirect and will be described in detail below:

1. Direct presentation

In a direct presentation cash flow from operating expenses, revenue is accounted for when cash is received. Therefore, the presentation of cash flow represents actual monies received and where they go within an accounting reporting period. This method of reporting reflects actual cash in-flows and out-flows. Examples of operating cash flow in this context include:

  • All money paid to third parties

  • Employee salaries dispensed during the period

  • Money collected from clients and customers

  • Additional income received from interest, investments or dividends

  • Income tax and interest on investments paid out

Related: Operations Management: Everything You Need To Know

2. Indirect presentation

It's more common for businesses to use indirect presentation. Using this technique, accountants look at operating cash flow in terms of the amount earned vs. actual money received. This method begins with net revenue and backs cash flow out of that number.

On a statement of cash flow showing indirect presentation, the top row would show net income in one column. Below that, subsequent rows show debits and gains from things like depreciation expense, amortization, cost-of-doing-business expenses, investment interest gained or spent, sale of equipment and property and more items that make up operating income.

At the bottom of the report, a number indicates the total cash from operating activities after adjustments have been made to net income to account for all in-flows and out-flows.

Learn more: 10 Accounting Interview Questions

Indirect vs. direct presentation: Which to choose?

It's important to determine which method is right for your business.

In practice, the indirect method of reporting cash flow makes sense for a lot of businesses. For one, many businesses use an accrual method of accounting which accounts for revenue as it is earned, rather than when it is deposited in the company's account. The indirect method is in line with this common accounting practice.

It's also a useful resource because it's easier to handle. It's a simple deduction of net income, and the line items can all be found on a properly prepared income statement and balance sheet, which means filling in your cash flow statement is just a matter of putting in the correct data and calculating the answer.

While it is an easier and more common practice to use the indirect method to prepare your next cash flow statement for an accounting period, it isn't favored by regulatory bodies that sometimes demand more accuracy from the businesses they enforce compliance with.

The Financial Accounting Standards Board (FASB) recommends businesses use the direct method of creating a cash flow statement. That said, FASB also requires accountants who use the direct method to follow similar reporting requirements that would have been present in the indirect method, so they have to complete an extra step on top of the already complex method of accounting for cash flow.

FASB asks all accountants who use the direct method to create a reconciliation report that ensures the accuracy of cash reporting. If you're in an industry that is highly regulated, you may find that complying means reporting the direct method of cash flow with reconciliation statement, versus the more simple indirect approach used by several companies.

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