Do you ever feel like every decision you make in your business feels like a leap into the unknown? Operating cash flow (OCF) could be the metric that lights your path ahead, making those decisions more informed and less nerve-racking.
In this KPI glossary entry, we'll deep dive into this metric, and why understanding OCF can change how you perceive your business's financial health.
Operating cash flow signifies the cash generated from your business’s operations.
OCF can magnify what truly keeps the business engine running: your core operations. This makes it an invaluable financial formula for evaluating the sustainability and efficiency of your business.
When we talk about cash flow, we're focusing on the movement of actual cash from operations, disregarding any non-cash accounting entries.
The OCF gives a clear picture of the amount of cash your business generates from its operations. This is crucial because it isolates the core business activities from other financial ventures, like investments and financing.
If you're an investor, OCF is a vital indicator of a business's financial health, revealing if a business can generate enough cash flow from operations to grow without relying on external financing. For business owners, OCF ensures that the daily functions, like paying employees and buying supplies, are sustainable through generated revenue.
Moreover, understanding operating cash flow can reveal inefficiencies. If there's a disparity between strong revenue and low OCF, it suggests problems in cash collection or excessive spending. By focusing on these inefficiencies, businesses can adjust strategies to improve cash generation from their operations.
Cash flow forecasting can help your business to anticipate your business's future cash flow needs and plan accordingly. If you'd like to learn more about cash flow forecasting, you can read more about this in our comprehensive guide: what is cash flow forecasting?
Operating cash flow is a financial lifeline that measures a business's ability to produce sufficient cash. It does more than just tell you if you're making money; it reveals if you can cover debts and operational expenses with cash generated from your core business activities.
Positive OCF is vital, as it helps your business to have the means to pay employees, suppliers, and lenders. This steady inflow of cash is particularly critical for small businesses that can't afford extended cash flow shortages. Investors often eye OCF because it indicates the feasibility of long-term investments without the need for extra financing.
For small businesses, strong cash flow from operations allows for better planning for future growth. It can provide the necessary funds for expansion projects, new product lines, or even market diversification. During economic downturns, a strong OCF acts as a buffer, protecting the business from financial instability.
OCF isn't just about your current financial health. It's forward-looking financial analysis that helps businesses anticipate future cash needs and adjust strategies accordingly. For more information on examining your business’s revenue streams, check out our guide to profitability analysis.
By focusing on OCF, small business owners can make data-driven decisions that steer their company toward sustained growth and success.
Calculating operating cash flow might seem daunting, but it follows a straightforward formula.
The direct method involves recording all transactions in cash immediately as they occur. This may include cash paid by your customers, dividends and interest income, your employees' salaries, cash paid to vendors, and interest or income tax.
Operating cash flow = total revenue - operating expenses
The indirect method for operating cash flow calculation refers to where your net income to cash by using changes to any of your non-cash accounts, which may include depreciation, accounts payable, and accounts receivable.
Operating cash flow = (revenue – cost of sales) + depreciation – taxes +/- change in working capital
Accurately calculating OCF aids in making informed business decisions. For instance, if your OCF is consistently low, there may be inefficiencies in your revenue collection process or excessive operational costs. Understanding these nuances helps you tweak your strategies to optimise cash flow, ensuring your normal business operations remain financially healthy.
Let’s bring the concept of operating cash flow to life with a real-world example.
Suppose you’re running a very small business that reports a net income of $100,000.
This example shows how different operational activities influence your cash inflows. Understanding such dynamics allows small business owners and investors to get a more accurate picture of the cash available for day-to-day operations.
Real-world examples make the concept of OCF tangible and comprehensible. By breaking down these numbers, you see how each component: depreciation, inventory, receivables, and liabilities, affects your cash flow, giving you actionable insights.
Net income refers to all your business earnings, while operating cash flow focuses solely on cash-based operations.
Operating cash flow removes non-cash expenses like depreciation and amortization from consideration. If your business shows strong net income but poor cash flow, it might not have the cash sufficient for daily operating costs. On the flip side, a robust OCF with modest net income can signify you're managing cash effectively.
Investors rely on OCF to gain a more realistic understanding of your business's financial health. It’s a clear-cut metric that tells you if a business can sustain itself through its core activities. Comparing net income and OCF offers hidden insights into a company’s financial dynamics, revealing whether the business is genuinely profitable or just appears so on paper.
To summarise, while both metrics are essential, OCF provides a clearer picture of a business’s ability to generate cash, which is crucial for operational sustainability and growth.
Operating cash flow and free cash flow (FCF) often get confused, but they serve different purposes in financial analysis.
Operating cash flow measures the cash generated from your core business activities, giving an insight into how well your operations are performing.
Free cash flow, on the other hand, accounts for capital expenditures like equipment and infrastructure investments. FCF provides a broader view of financial health by subtracting capital expenses from OCF. It gives investors an idea of potential returns after reinvesting in the business. FCF is one of Fathom's default KPIs.
Both OCF and FCF play complementary roles. Understanding the distinction helps in a comprehensive business evaluation. While OCF focuses on your immediate operational health, FCF offers a look at long-term sustainability and growth opportunities.
As a small business owner, knowing both these metrics enables you to make more informed strategic decisions, balancing day-to-day operations with future investments.
Understanding operating cash flow can be a game-changer for any small business owner or advisor. This KPI metric provides a realistic snapshot of your financial health, focusing on cash generated from your core business activities.
By calculating OCF accurately, you can identify inefficiencies and make informed decisions to improve your business’s financial stability. Remember, the insights OCF provides can be a guiding light to your business.
Did you know Fathom automatically calculates a comprehensive range of financial KPIs, including your operating cash flow? For more information, check out our list of default KPIs or visit our help centre.
Additionally, explore our tutorial webinars and testimonials on the Fathom blog.
KPI tracking software can be used by businesses looking to get a clearer understanding of their performance, by tracking Key Performance Indicators (KPIs) and metrics that matter to their business.
For more information on defining and tracking the KPIs that are most important to your company, watch our KPIs Demystified webinar.
We have also written glossary entries on other default Fathom KPI’s that you may want to explore, such as cash flow margin, cash flow coverage ratio, and cash flow adequacy ratio.
Smarter growth starts with the right metrics. With Fathom, you can select from 50+ common financial KPIs or create your KPIs for a comprehensive view of business health and performance. If you're not yet a Fathom user, remember you can explore the capabilities of our KPI tracking software when you start a free 14-day trial today.
Investopedia defines the operating cash flow ratio as a measure of how readily current liabilities are covered by the cash flows generated from a company's operations.
Operating cash flow indicates the cash that a company has available to cover its day-to-day expenses.
To calculate operating cash flow, you can start with the company's net income and then add back non-cash expenses like depreciation and amortization. Next, you subtract any changes in working capital and operating expenses.
Free cash flow (FCF) is the cash flow available after all expenses and investments have been accounted for, whereas operating cash flow (OCF) focuses solely on the cash generated from a company's operations before deducting interest and taxes.
No, operating cash flow and earnings before interest and taxes (EBIT) are not the same. EBIT is a measure of a company's profitability, while operating cash flow focuses on the cash generated from the company's core operations.
EBIT Growth is a default KPI in Fathom.
When revenue is recorded on your balance sheet, it doesn't always mean you have that cash in hand. By delving into the concept of OCF, you're equipping yourself with insights that directly impact your operational and strategic choices.
Kit is the Content Marketing Manager for The Access Group APAC and Fathom. He is a former journalist with extensive experience in content writing and copywriting across various industries, including higher education, not-for-profit, and finance sectors.
