Operating Cash Flow (OCF)

Operating cash flow is a measure of the amount of cash generated by a company's normal business operations. Operating cash flow indicates whether a company can generate sufficient positive cash flow to maintain and grow its operations, or it may require external financing for capital expansion. Generally Accepted Accounting Principles (GAAP) require public companies to calculate operating cash flow using an indirect method by adjusting net income to cash basis using changes in non-cash accounts, such as depreciation, accounts receivable, and changes in inventory.

Operating cash flow represents the cash version of a company's net income. Because Generally Accepted Accounting Principles (GAAP) requires the net income (NI) to be reported using an accrual basis, it includes various non-cash items, such as stock-based compensation, amortization, and expenses that were incurred but not paid for. Also, net income must be adjusted for any changes in working capital accounts on a company's balance sheet. Increases in accounts receivables represent revenues booked for which cash has not yet been collected, and such increases must be subtracted from the net income. However, reported increases in accounts payable represent expenses accrued, but not paid for, resulting in addition to the net income.

Operating cash flows concentrate on cash inflows and outflows related to a company's main business activities, such as selling and purchasing inventory, providing services, and paying salaries. Any investing and financing transactions are excluded from operating cash flows and reported separately, such as borrowing, buying capital equipment, and making dividend payments. Operating cash flow can be found on a company's statement of cash flows, which is broken down into cash flows from operations, investing, and financing.

Consider a manufacturing company that reports a net income of $100 million, while its operating cash flow is $150 million. The difference results from adding to the net income a depreciation expense of $150 million, subtracting increases in accounts receivable of $50 million, adding decreases in inventory of $50 million, and subtracting decreases in accounts payable of $100 million.

Financial analysts sometimes prefer to look at cash flow metrics because they strip away certain accounting effects and are thought to provide a clearer picture of the current reality of the business operations. For example, booking a large sale provides a big boost to revenue, but if the company is having a hard time collecting the cash, then it is not a true economic benefit for the company. On the other hand, a company may be generating a high operating cash flow but reports a very low net income if it has a lot of fixed assets and uses accelerated depreciation calculations.