Cash generated from operating activities of a business Show
What is Operating Cash Flow?Operating Cash Flow (OCF) is the amount of cash generated by the regular operating activities of a business within a specific time period. OCF begins with net income (from the bottom of the income statement), adds back any non-cash items, and adjusts for changes in net working capital, to arrive at the total cash generated or consumed in the period. When performing financial analysis, operating cash flow should be used in conjunction with net income, free cash flow (FCF), and other metrics to properly assess a company’s performance and financial health. Operating Cash Flow ExampleBelow is an example of operating cash flow (OCF) using Amazon’s 2017 annual report. As you can see, the consolidated statement of cash flows is organized into three distinct sections, with operating activities at the top, then investing activities, and finally, financing activities. In addition to those three sections, the statement also shows the starting cash balance, total change for the period, and ending balance. Let’s analyze how the operating section works:
Image: CFI’s Advanced Modeling Course – Amazon Case Study. At the bottom of the operating cash flow section, we can see the total, which is labeled as “Net cash provided by (used in) operating activities.” The line is the sum of all items above it and represents the total for the period. Operating Cash Flow FormulaWhether you’re an accountant, a financial analyst, or a private investor, it’s important to know how to calculate how much cash flow was generated in a period. We may sometimes take for granted when reading financial statements how many steps are actually involved in the calculation. Let’s analyze the operating cash flow formula and each of the various components. Formula (short form): Operating Cash Flow = Net Income + Non-Cash Expenses – Increase in Working CapitalFormula (long form): Operating Cash Flow = Net Income + Depreciation + Stock Based Compensation + Deferred Tax + Other Non Cash Items – Increase in Accounts Receivable – Increase in Inventory + Increase in Accounts Payable + Increase in Accrued Expenses + Increase in Deferred RevenueThe formulas above are meant to give you an idea of how to perform the calculation on your own, however, they are not entirely exhaustive. There can be additional non-cash items and additional changes in current assets or current liabilities that are not listed above. The key is to ensure that all items are accounted for, and this will vary from company to company. Operating Cash Flow vs Net IncomeNet income and earnings per share (EPS) are two of the most frequently referenced financial metrics, so how are they different from operating cash flow? The main difference comes down to accounting rules such as the matching principle and accrual principle when preparing financial statements. Net income includes all sorts of expenses, some that may have actually been paid for and some that may have simply been created by accounting principles (such as depreciation). In addition, a company’s revenue recognition principle and matching of expenses to the timing of revenues can result in a material difference between OCF and net income. Unfortunately, it is not possible to simply say that one number is always higher or lower than the other. Sometimes OCF is higher than net income (as with Amazon, shown above) and sometimes it’s the opposite. Source: Amazon.comImage: CFI’s Advanced Modeling Course – Amazon Case Study. As you can see in the screenshot above, there is a major difference between the two metrics, and Amazon has constantly generated more OCF than net income. To be fair though, what OCF doesn’t take into account is capital expenditures (CapEx) or purchases of PP&E. By deducting CapEx from OCF you arrive at Free Cash Flow, which is a better assessment of available cash generated for the period. Operating Cash Flow in Financial ModelingCalculating the cash flow from operations can be one of the most challenging parts of financial modeling in Excel. Below is an example of what this activity looks like in a spreadsheet. As you can see in the screenshot, there are various adjustments to items necessary to reconcile net income to net cash from operating activities, as well as changes in operating assets and liabilities. In a financial model, there are separate sections for the depreciation schedule and working capital schedule, which then feed into the cash flow statement section of the model. The example below is taken from CFI’s Amazon Case Study Course. Image: CFI’s Advanced Amazon Modeling Course. As you can see in the above example, there is a lot of detail required to model the operating activities section, and many of those line items require their own supporting schedules in the financial model. Video Explanation of the Statement of Cash FlowsBelow is a short video tutorial explaining how the three sections of a cash flow statement work, including operating activities, investment activities, and financing activities. Additional ResourcesThank you for reading this CFI guide to Operating Cash Flow. To continue learning and progressing your career, these additional CFI resources will be helpful:
What is the formula to calculate operating cash flow with the indirect method?Take your accrual net income plus depreciation and subtract your change in accounts receivable, change in inventory, and change in accounts payable. Then add any noncash expenses and subtract any customer deposits.
How to calculate operating activities using the indirect method?Calculating Cash Flow from Operations using Indirect Method. Start with Net Income.. Subtract: Identify gains or losses that result from financing and investments (like gains from the sale of land). Add: Non-cash charges to income (such as depreciation and goodwill amortization. ... . Add or subtract changes to operating accounts.. What is operating cash flow formula?Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital.
What is the indirect method?The indirect method is a method used in financial reporting in which the statement of cash flows begins with the net income before it is adjusted for the cash operating activities before an ending cash balance is achieved.
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