While net income and earnings per share (EPS) are critical financial measurements, operating cash flow can determine how much capital you have generated after accounting for taxes, general operating costs, and depreciation.
While net income and earnings per share (EPS) are critical financial measurements, operating cash flow can determine how much capital you have generated after accounting for taxes, general operating costs, and depreciation. While operating cash flow is not the bottom line, it is a significant piece of the puzzle, giving you a better picture of the overall health of your business.
Operating cash flow represents main business activities such as buying & selling inventory and paying salaries. It is crucial to note that all investing and financing activities will not be from this formula. Instead, operating cash flow appears on the statement of cash flows which is broken down and used to show reports for investing, managing, and financing. Operating cash flow is critical for better understanding your business and the future possibilities. If you and your company are looking to expand, knowing your operational cash flow is essential so you can gain the support and trust of investors.
The operating cash flow formula is broken down into a simple formula: Operating Cash Flow = Net Income + Non-cash Expenses (Depreciation) +/- Changes in Working Capital.
It is important to note, OCF does not include interest received or paid and any dividends paid.
Many intricacies can make accurately calculating operating cash flow tricky. Having a trained specialist like a Fractional CFO can ensure proper reporting to the GAAP (Generally Accepted Accounting Principles). Hiring an industry specialist with a wide range of knowledge can not only ensure credibility, but highlight missed factors of the equation.
The indirect method is the required method from generally accepted accounting principles. The indirect method provides much more intricate detail of how different areas of a business are performing. Below is the equation:
Operating Cash Flow = Net Income +/- Changes in Assets & Liabilities (including the increase in accounts receivable, inventory, and accounts payable) + Non-Cash Expenses
Boiling it down, operating cash flow is the ending amount after all bills have been paid. Thus, companies can see where resources have been allocated and help with future investments, ventures, or expansions.
The direct method is more simple yet does not paint the most precise picture of the cash health of a business. In addition, while it can be helpful, finding the reporting number through the direct method by the standards of generally accepted accounting principles is not validated.
The direct method is equal to revenue - operating expenses. While still functional, the direct approach is not advised to be used on its own as it does not provide enough material to base financial decisions.
Operating cash flow helps measure the cash flow to make clear the health of a business’s financial operations while being a vital tool in setting realistic goals for growth and expansion in your business. In addition, it can be instrumental in gauging the long-term stability and health of a company.
Fractional CFOs can be of significant value when assessing Operating Cash Flow. Not only are they skilled in calculating this information, but they also provide the knowledge to allocate the funds best, helping achieve the goals your business may have. Through keen listening, Fractional CFOs can prioritize and allocate funds from operating cash flow, free from judgment and bias, to attain those dreams and maximize potential. Operating cash flow is not the bottom line of every business but is the heartbeat. Therefore, every company must first know how to calculate the operating cash flow to ensure you have a solid heartbeat and continue growing.