Operating Cash Flow Defined

Businesses often focus in on net income and fail to recognize the significance of cash flow (see Cash Flow – The Bottom Line) and what determines cash flow (see Cash Management-It’s Not About the Cash Account). Even when understanding the importance of cash flow and what generates it, there are some additional aspects to understand.

What is Operating Cash Flow

In a future blog I will show how the cash flow statement is created, but for now let’s just identify the three main components of the statement, which are:

  • Operating Activities
  • Investing Activities
  • Financing Activities

Here we will just be looking at cash flow as impacted by operations.

Determining Cash Flow from Operations

To distinguish operating cash flow from other things that impact cash flow, the statement of cash flows has a section called Cash Flow Provided by Operations. Essentially the cash flow from operations is calculated as Net Income adjusted for non-cash charges and changes in current assets and liabilities. The reason changes in current assets and liabilities impacts this is because this is where operating activity flows through. Non-cash charges include such things as depreciation and amortization. It also removes the impact of interest and income taxes. EBIT stands for earnings before interest and taxes. Here is an example of the calculation:

calculating operating cash flow

Note how decreases in current assets and increases in current liabilities increase the operating cash flow and increases to current assets and decreases to current liabilities decrease operating cash flow.

Why Operating Cash Flow Matters

Isolating the operating cash flow from the total cash flow calculation allows you to see the cash effect of day-to-day operations, thus removing the impact of financing and investing activities. This is a worthwhile measure of how well a business is performing. It is a better measure of liquidity than net income. Also, when only the total cash flow is considered the effect of operations can be masked by such things as additional loans. As such, it is a better measure of financial health than the total cash flow.

Are you measuring your cash flow? If so, that is good. But dig little deeper and look at the operating cash flow to better understand how operations influence your cash.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.


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