Cash Flow From Operating Activities (CFO)

Cash flow from operating activities (CFO) is an accounting item that indicates the amount of money a company brings in from the ongoing regular business activities, such as manufacturing and selling goods or providing a service. Cash flow from operating activities does not include long-term capital expenditures or investment costs, as they may be one time activities. CFO focuses only on the core business, and is also known as operating cash flow (OCF) or net cash from operating activities.

Cash flow forms one of the most important parts of business operations, and accounts for the total amount of money being transferred into and out of a business. Since it affects the cash liquidity that is available within a business, it gains significance for multiple reasons. They include allowing business owners and operators check where the money is coming from/going to, help them take steps to generate and maintain sufficient cash necessary for operational efficiency and other necessary needs, and help in making key and efficient financing decisions. The details about the cash flow of a company are available in its cash flow statement, which is a part of standard financial reporting on quarterly and annual basis.

The cash flow statement of a company is divided into three sections - cash flow from operating activities, cash flow from investing, and cash flow from financing activities. Collectively, all three sections provide a picture of where the company's cash comes from, how it is spent, and the net change in cash resulting from the firm's activities during a given quarter or year. The cash flow from investing shows the cash used to purchase fixed and long-term assets, such as plant, property, and equipment (PPE), and also any proceeds from the sale of these assets. The cash flow from financing shows the source of a company's financing and capital, and its servicing and payments on the loans. For example, proceeds from the issuance of stocks and bonds as well as dividend and interest payments will be included under financing activities.

The cash flow from operating activities constitutes the revenue-generating activities of a business. Indicating the cash-generating abilities of a company's core business activities, this section tells how much cash a company generated from its core business operations and is reported on a company's quarterly and annual reports. It typically includes net income from the income statement, adjustments to net income, and changes in working capital which is used to cover all of a company's short-term expenses, including inventory, payments on short-term debt and operating expenses. 

Different reporting standards are followed by companies as well as the different reporting entities which may lead to different methods of calculations. Depending upon the available figures, CFO value can be calculated by one of the following methods, and both yield the same result:

1. Cash Flow from Operating Activities = Funds from Operations + Changes in Working Capital

where, Funds from Operations = (Net Income + Depreciation, Depletion & Amortization + Deferred Taxes & Investment Tax Credit + Other Funds)

This format is used for reporting Cash Flow details by finance portals like MarketWatch.

Or

2. Cash Flow from Operating Activities = Net Income + Depreciation + Adjustments To Net Income + Changes In Accounts Receivables + Changes In Liabilities + Changes In Inventories + Changes In Other Operating Activities

This format is used for reporting Cash Flow details by finance portals like Yahoo! Finance.

All the above mentioned figures included in the above mentioned versions are available as standard line items in the cash flow statements of the companies.

The net income figure comes from the income statement. Since it is prepared on an accrual basis, the noncash expenses, such as depreciation and amortization, are added back to the net income. In addition, any changes to the working capital, such as an increase and/or decrease in current assets and current liabilities are also added to the net income to account for the overall cash flow.

Inventories, tax assets (deferred and credits), accounts receivable, accrued revenue and deferred revenue are common items of assets for which a change in value will be reflected in cash flow from operating activities. Accounts payable, tax liabilities and accrued expenses are common examples of liabilities for which a change in value is reflected in cash flow from operations. From one reporting period to the next, any positive change in assets is recorded as a cash outflow for calculations, while a positive change in liabilities is recorded as a cash inflow. 

In essence, the calculation for Cash Flow from Operating Activities adjusts for receivables, liabilities, taxes and depreciation, and more accurately measures the amount of cash a company has generated (or utilized).

Let’s look at the cash flow details of the leading technology company Apple Inc. (AAPL). The iPhone maker had a Net Income of $48.35 billion, Depreciation, Depletion & Amortization as $10.16 billion, Deferred Taxes & Investment Tax Credit as $5.97 billion and Other Funds as $4.67 billion for the fiscal year ended September 2017. Following the first formula, the summation of these numbers brings the value for Fund from Operations as $69.15 billion. The net Change in Working Capital for the same period was (-5.55 billion). Adding it to Fund from Operations gives the Cash Flow from Operating Activities for Apple as ($69.15 - $5.55) = $63.6 billion.

One must note that working capital is an important component of cash flow from operations, and companies can manipulate cash flow from operating activities by delaying the bill payments to suppliers, accelerating the collect of bills from customers, and delaying the inventory purchase. All these measures allow a company to retain cash. Companies also exercise liberty for which items they consider as qualifying for capital expenditures and which items not qualifying for capital expenditure, and the investor should be aware of these considerations when comparing the cash flow of different companies. Due to such flexibility exercised by the companies where they can tweak the details to a certain extent, CFO figure is more popularly used for comparing a company's performance between two reporting periods, instead of comparing one company to the other even if the two belong to the same sector.

For the second method, summing up the available values from Yahoo! Finance portal that reports Net Income ($48.35 billion), Depreciation ($10.16 billion), Adjustments To Net Income ($10.64 billion), Changes In Accounts Receivables (-$2.093 billion), Changes In Liabilities ($8.992 billion), Changes In Inventories (-$2.723 billion) and Changes In Other Operating Activities (-$9.726 billion) gives the net CFO value as $63.6 billion for Apple.

Both the methods yield the same value.

Cash availability allows a business the necessary options to expand, build and launch new products, buy back shares to affirm their strong financial position, pay out dividends to reward and bolster shareholder confidence, or reduce debt and save on interest. Analysts and investors look to cash flow from operations to get important insights into the core of the cash-generating drivers of a company. Investors attempt to look for companies whose share prices are lower and cash flow from operations is showing an upward trend over recent quarters. The disparity indicates that the company has increasing levels of cash flow which if better utilized can lead to higher share prices in near future.

Investors also examine a company’s cash flow from operating activities to determine where a company is really getting its money from. In contrast to investing and financing activities which may be one-time or sporadic, the operating activities are core to the business and are recurring in nature. The CFO figure provides a much better assessment of how a business is operating for its core activities. Ideally, investors would like to see a positive (and increasing) cash flow that indicates positive income emerging from the recurring operating activities. It provides as additional measure/indicator of profitability potential of a company, in addition to the traditional ones like net income or EBITDA.