Operating Cash Flow

What is Operating Cash Flow?

Operating Cash Flow (OCF) is a metric used to measure the amount of cash generated by a company's operations and activities, such as production and selling of goods and services. It is a measure of the financial performance of a company, and is often used by investors, creditors, and other stakeholders to assess the financial health of the company.

Why Operating Cash Flow is Important

Operating Cash Flow is an important metric for companies because it indicates the amount of cash that can be used to pay for operating expenses, such as payroll, rent, and other bills. It is also used to measure the company’s ability to generate cash from its operations and activities. Furthermore, Operating Cash Flow can be used to measure the company’s ability to generate returns on investments, which is an important factor in making decisions about investing in the company.

How Operating Cash Flow is Calculated

Operating Cash Flow is generally calculated by taking the company’s net income, adding back in non-cash expenses such as depreciation and amortization, and subtracting any changes in working capital (e.g., inventory and accounts payable). The formula for Operating Cash Flow is:

Operating Cash Flow = Net Income + Depreciation & Amortization + Changes in Working Capital 

For example, let’s say a software company, Company A, has a net income of $1 million, depreciation and amortization expenses of $500,000, and a decrease in working capital of $250,000. The Operating Cash Flow for Company A would be calculated as follows:

Operating Cash Flow = $1,000,000 + $500,000 – $250,000 = $1,250,000

How to Improve Operating Cash Flow

There are a number of ways that companies can improve their Operating Cash Flow, including:

• Increasing sales: Increasing sales can help improve Operating Cash Flow by increasing the amount of cash generated from operations.

• Improving efficiency: Companies can improve their efficiency by reducing costs and improving productivity, which can help to improve Operating Cash Flow.

• Reducing inventory: Companies can reduce their inventory levels, which can lead to a decrease in working capital and an increase in Operating Cash Flow.

• Increasing debt: Companies can increase their debt, which can help to generate cash for operations and increase Operating Cash Flow.

Why Investors Value Strong Operating Cash Flow

Strong Operating Cash Flow is important to investors because it indicates the company’s ability to generate cash from its operations. Investors often use Operating Cash Flow as one of the key indicators of a company's financial health. Companies with strong Operating Cash Flow are generally seen as more attractive investments, as they are more likely to generate returns for investors.

How Operating Cash Flow Relates to Other Financial Metrics

Operating Cash Flow is closely related to other financial metrics, such as Return on Equity (ROE). ROE is a measure of how efficiently a company is using its equity to generate profits. Companies with higher Operating Cash Flow tend to have higher ROE, as they are able to generate more cash from their operations.

Sources

• Investopedia. (n.d.). Operating Cash Flow. Retrieved from https://www.investopedia.com/terms/o/operatingcashflow.asp

• Investopedia. (n.d.). Return on Equity (ROE). Retrieved from https://www.investopedia.com/terms/r/returnonequity.asp

• Investopedia. (n.d.). What Is Working Capital? Retrieved from https://www.investopedia.com/terms/w/workingcapital.asp