Operating Cash Flow (OCF): Definition, Formula, Types and Example

When it comes to running a business, monitoring and keeping on top of financial performance can be challenging.

Without knowing the right financial performance metrics, issues tend to get overlooked and cause problems down the line.

Understanding the role of specific metrics like operating cash flow can help evaluate a business and its financial health while also spotting any money issues preemptively.

This article will help break down operating cash flow, why it is so important and how to calculate it.

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This article will look at:
What is operating cash flow? Importance of operating cash flow Operating cash flow types Operating cash flow indirect method Operating cash flow direct method Operating cash flow formula Operating cash flow example

What is operating cash flow?

Operating cash flow refers to the inflow and outflow of cash generated by a business during its normal operations.

It is one of the core components of a cash flow statement, which is a summary of cash and cash equivalents entering and leaving the business.

A cash flow statement is important because:

• It’s an important aspect in assessing overall financial health of a business
• It gives you a clear understanding of business costs by showing you cash inflow and outflow
• For international businesses, cash flow statements can help with understanding different costs across markets and tackling multi-currency requirements as needed

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cash flow statement template

Note that operating cash flow is different from operating cash flow ratio.

Operating cash flow ratio is used to understand if a company can pay off its liabilities or payables (i.e. any money owed by the business at any time) with cash generated from business activities.

Importance of operating cash flow

Calculating and monitoring operating cash flow is important for a variety of reasons.

• First and foremost, it helps you keep track of your business and its financial performance, which takes on even more importance if you operate in multiple locations.

• Having positive operating cash flow can indicate that your business has a bit of room or flexibility with your cash reserves/free cash flow.

• OCF can help you evaluate performance in different locations and overall financial health - around both international and domestic operating costs.

• It is also crucial for future planning, as it gives you an idea of how the business is doing, whether operations are in a place and if expansion is possible.

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Operating cash flow types

There are two different methods to display cash flow from operating activities on a cash flow statement:

• indirect
• direct

Let’s look at the differences between each one in more detail.

Indirect method¹	Direct method¹
Uses net income as a base	Uses all cash transactions as a base
Net income and depreciation expense is included (all factors are included)	Net income and depreciation expense isn’t included (non-cash transactions are ignored)
Changes in assets and liabilities are included	Changes in assets and liabilities are not included
Useful for larger businesses with diverse income sources	Better for smaller businesses that may not have long-term assets to include

Operating cash flow - indirect method

The indirect method for calculating cash flow includes net income and non-cash adjustments.

The net profit or loss the company reports are adjusted for items that affect the figure but do not involve cash, such as depreciation and amortization.

For example, the indirect method would calculate net income and then adjust it for inventory depreciation, such as older equipment the company owns but has depreciated.

The indirect method could also include currency exchange adjustments and impact, such as foreign currency translation and fees.

💡 Foreign currency translation - International businesses
For companies operating in multiple countries, foreign currency translation refers to converting money from foreign locations to the parent company’s currency. The conversions to different currencies can lead to higher fees, loss of revenue -due to high conversion rates- and difficulty reconciling transactions. In turn, this can affect operating cash flow.

That's why using a multi-currency account, like Wise can help with making cash flow management easier, and reducing the impact of conversion fees and foreign currency translation.

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In 54 currencies with Wise

Operating cash flow - direct method

The direct method for calculating operating cash flow looks at all cash transactions, including accounts payable and receivable.

It’s a summary of the inflow and outflow of cash, in a specific reporting period, using all cash transactions as a basis for calculation.

For example, that figure would include cash received from customers, cash paid to suppliers and employees.

Operating cash flow formula

There are two versions of the operating cash flow formula that can be used, a short version or a long version.

The formula you use will depend on your individual business. Note that formulas can be adjusted as needed for items not mentioned below.

What’s most important is to ensure that you have included all relevant items for your business in the formula to ensure the calculation is accurate.

Short formula:

Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital

Long formula

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

Operating cash flow - Example

To help with understanding how to calculate operating cash flow, here is an example using the Wise cash flow statement template.

Get your free CF statement in a click

To use the statement, you’ll need to add in figures from your business so that the template can automatically calculate your operating cash flow.

Starting with operating activity, you’ll need to enter figures for:

• Customers
• Other operations
• Cash paid for
• General operating and admin expenses
• Wage expenses
• Interest
• Income taxes

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You can enter year-end and current figures to compare cash flow at the beginning versus now. You’ll then see a calculation of your net profits from operating activity.

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Once you’ve entered those categories, you’ll then move on to the additions and subtractions of the cash section. For this section, you’ll need to enter figures for depreciation and amortization as calculated for your business. You’ll then enter figures for subtractions from cash, which includes increases in accounts receivable and inventory.

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After this has been added, you’ll get a final figure that shows the total cash from operating activities.

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Calculating operating cash flow gives you better insight into a business’ operating activities and costs incurred.

Doing so can help you plan for the future and ensure that your business operates in a sustainable way that allows it to grow and expand.

That’s why it’s so crucial to plan ahead and consider any operational costs that can be reduced to help your business perform better - and it’s even more crucial when paying or receiving money from overseas is in the picture as that can drive up costs.

Luckily, you don’t need to worry about that with Wise. Using Wise, businesses can save up to 19x compared to PayPal

You can use the multi-currency account to manage money and keep track of costs in a streamlined way, as the account allows you to hold up to 54 currencies in one place.

If your business has customers overseas, you can also get full account details (IBAN, Routing Number or Sort Code) in up to 10 currencies, making it easier to get your invoices paid faster and on time.

And with Wise, you’ll always see an upfront, transparent fee and send money with the mid-market rate to help you grow your business and keep down costs.

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Sources:

1. Investopedia - Cash flow from operating activities

All sources checked 06 October 2021