Operating Cash Flow - Formula, Definition, Examples

Lidia Staron, author at OpenLoans
Lidia Staron   Head of Content
Personal Finance
I enjoy navigating people through important financial decisions.

Any small business owner needs to monitor cash flow to ensure there is enough to cover all outgoings. For many businesses, cash flow can be disrupted by clients being slow to pay their invoices, seasonality, and other factors that might hit your bottom line.

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You can use an operating cash flow formula to help you work out your business's income and make any adjustments. It could be that some short-term borrowing via a business or personal loan helps you out in times when your cash flow takes a dip.

Cash flow.

In a big business, you might have a whole department dedicated to making these sorts of calculations. It's a massive task if your company has a high turnover and many expenses and moving parts, where accountants come in. But for a small business, it helps if you can at least do some rough projections and calculations yourself to make sure that your business is remaining viable.

How to Calculate Cash Flow?

There are a few different methods you can use when calculating your cash flow. A lot of people use OCF, meaning operating cash flow. The simple formula for this is:

Operating cash flow = Business net income + Non-cash expenses - Increases in your working capital

This is a simplified version of the operating cash flow formula. Still, it can certainly help you understand how to calculate operating cash flow from activities within your business.

Other methods of calculating include:

  • Free Cash Flow. This means you calculate "Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure."
  • Cash Flow Forecast. This means you work out your Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash. More on cash flow forecast later.

It can feel intimidating looking at these calculations and trying to work out how you will use them in your business. Still, it is just a case of feeding a few numbers into the formulas, and you should be able to work out whether you have enough cash flow to get through the months ahead.

Why Calculate Business Cash Flow?

You might not think it's that important in a small business. In truth, it may be even more vital for smaller organizations, as you probably don't have as much to fall back on financially.

By calculating your operating cash flow, you can work out how much money the business will have available at any one time. Even a relatively healthy company can struggle if the cash flow gets tight. An unexpected expense can impact if the business doesn't have money on hand to pay for it.

Calculating operating cash flow is a sensible thing to do. Without it, a sudden influx of Cash from one contract or sale might give a misleading representation of how much the business makes each month or year.

Operating cash flow does an excellent job of showing a typical, month-to-month cash flow. Other cash flow calculations such as free cash flow might not give you the data you need.

OCF has become a great way to understand cash flow, and it is used a lot in the financial industries or even for venture capitalists who might be looking into your business. It's a sort of universal language for accountants to understand how your business is functioning.

The indirect method of cash flow is an alternative used by some smaller businesses, which is a simplified way of starting with your net income on an accrual basis. It then adds and takes away non-cash items, which shows the cash flow from the business being carried out.

Operating Cash Flow Formula

So, what is the operating cash flow formula? Let's take a more in-depth look at the cash flow formulas for businesses and how they can help you plan.

Operating cash flow = Business net income + Non-cash expenses - Increases in your working capital

This means that you can start with the net income. If you work with an accountant or generate an income statement yourself, this is the starting point.

Add all non-cash items, too, including the depreciation or compensation you need to pay, as well as taxes you are responsible for at this time. Once you have worked all of this out, you can take it away from the total. You can also subtract changes to the working capital. This is where things like payable accounts and increases in receivable accounts need to be considered.

An example might help you understand how to calculate operating cash flow.

Let's say you start with $100,000 and add non-cash expenses of $50,000. Increases in the capital are then worth a further $100,000.

This would make your operating cash flow $50,000 for the period in question.

Operating Cash Flow and Net Income

Counting coins.

It's a good idea to be aware of two figures concerning your business. We've already discussed the operating cash flow meaning. A functional cash flow formula is a great way to work out how much you have come into your business at any time and to give a good overview of how healthy the company is. It also shows sustainability.

Net income has a few more variables. For a seasonal business, for instance, over a few months, it is easy to get a misleading image of the financial wellness of the company if you only look at net income.

Net income is only how much profit is coming into your business minus expenses and taxes, as well as the cost of any goods you sell. It doesn't account for things like depreciating assets. Those who run a taxi firm would need to know the value of their fleet will drop significantly.

Investors and financial analysts will look at both of these figures. It's a good idea to get your finances in order so that you know your operating cash flow. However, it is fair to say that your OCF is a reasonable forecast of your financial health as a business.

How to Forecast Cash Flow?

As well as having a formula for operating cash flow, it helps if you know how to calculate cash flow over time.

The cash flow forecast is a lot simpler than a lot of businesses. It's all based on what you envisage coming into your business or going out over a specific period. Even if you don't know any financial terminology, it's not hard to calculate this.

Your cash flow is usually calculated over a month or a quarter (90 days).

The formula involves taking your beginning cash (how much money you have within your business). Then, add projected inflows (money you are owed or will earn in this time) and subtract outflows (things your company is liable for in that time). This gives you your "ending cash," — meaning how much money you will have to hand at the end of this time.

Inflows and outflows are two terms that mean income and financial outgoings.

Inflows include current invoices that you will receive payment. Outflows can be anything you payout, either on a regular monthly basis, like your business rent, or something you buy as a one-off purchase, like a computer.

Forecasting cash flow in this way is not the same as OCF methods of working out your cash flow from operating activities. However, it can be a great help when it comes to an understanding of where you will be financially in the coming months. Even if this information is never shared with an accountant, it is still a fantastic way of making sure that you will have enough to cover expenses and that your business is making a profit.

Free Cash Flow Calculator

Your free cash flow is another calculation. There are online cash flow calculators you can use, or you can create a spreadsheet that allows you to work this out.

The free cash flow is how much money is available for the company. You can use this money to repay money owed, take as profits, or pay dividends to investors and shareholders. Some work out FCF, or even "FCF per share," working out what each business's share is worth. This takes the non-cash element out of the business calculations.

However, this method doesn't consider things like assets, and over time it can be quite an unreliable way of calculating how much money your business has available to you.

All of these ways of calculating have their pros and cons. The operating cash flow formula considers all of the assets of a business, which can mean more calculations for people. Still, it also can mean more of a wide-ranging overview of industries so that people externally can see the real value.

If you use free cash flow, this can give a simple method to work out how much money you might have to hand. However, if you spend a lot of money on equipment or expansion, it doesn't show any of this. The FCF cash flow calculator method would be distorted by what the business might be worth to investors.

Conclusion

When you calculate your cash flow and your net income, it is a good idea to use a few different methods. There are many ways to calculate operating cash flow. Using a cash flow calculator can answer questions about what profit is being made.

As we've already stated, knowing how to calculate your cash flow is nothing short of essential. Luckily, some online tools can help, and you can even feed your data into an Excel spreadsheet. That might provide you with a simple way to add some numbers and end up with an accurate forecast for the coming months.

Accountants play a vital role in most businesses. If you are more than just a one-person solo venture, then it is a good idea to have someone from a financial background help you work out all aspects of your business finances. Accountants can help you learn how to save money on taxes, which is always a nice bonus.

Your operating cash flow gives you an accurate overview of how well your business is doing.

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