Operating Cash Flow Explained: What Is Operating Cash Flow?

A company's operating cash flow (OCF) represents the net cash it generates from its day-to-day business operations. It is calculated using net income, which combines positive cash inflows from an accounts receivable department with negative cash outflows from an accounts payable department. When used in combination with other metrics, operating cash flow can be useful in determining the financial stability of a company.

There are two ways to measure a company's cash flow using generally accepted accounting principles (GAAP).

• Direct method: The direct method for showing operating cash flow on an income statement is to record all the transactions on a cash basis and provide records of cash inflows and cash outflows throughout the accounting period. Business owners use the direct method to record employee salaries, total revenue from customers, total revenue from investing activities, money paid to vendors and suppliers, money paid out for interest payments, and money paid out in taxes. Importantly, the direct method only covers actual monies paid and does not cover anticipated transactions from the accounts payable or accounts receivable departments.
• Indirect method: The indirect method of measuring cash flow from operating activities applies to companies that use accrual-based accounting. In contrast with the direct method, this method factors in anticipated transactions from the accounts receivable and accounts payable departments. It also considers amortization and depreciation expenses in non-cash items, such as the machinery a company owns. Financial analysts take these non-cash expenses into account when assessing the operating cash flow of a business.

In its simplest form, the operating cash flow formula (OCF formula) is:

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

Many other operating expenses and revenue sources may factor into an operating cash flow calculation. These include deferred taxes, inventory expenses, deferred revenue from accounts receivable, deferred payments from accounts payable, and changes to current liabilities and current assets.

At its core, operating cash flow reveals the short-term financial health of a company. Investors and pending business partners seek out OCF on financial statements to see whether a company generates enough money to continue its day-to-day business.

If a company has a negative operating cash flow, it means its current cash inflow cannot cover its current cash outflow. A business with a negative OCF must rely on other financing activities—such as borrowing against the value of its current assets—to finance its capital expenditures. Some investors may accept or expect a negative operating cash flow for a startup company, but established companies operating with a negative OFC ratio may be less likely to attract investors.

Under most business accounting standards, companies measure cash flow in one of three ways: operating cash flow, free cash flow, and cash flow forecast.

• Operating cash flow: Operating cash flow, or OCF, helps measure a company's financial health by factoring in its operating income (also known as earnings before interest and taxes, or EBIT) alongside its operating expenses. A positive OCF indicates the company can pay its bills using only its operating revenue. A negative OCF indicates the company must find other sources of money—typically via loans, taking on investors, or liquidating assets—to cover its operating expenses.
• Free cash flow: Free cash flow, or FCF, represents the cash flows a company receives after capital expenditures (such as the purchase of long-term assets) have been deducted and before interest payments have been accounted for. Free cash flow appears on financial statements to show not only a company's incoming cash flow but also how it manages capital expenditures (sometimes called CAPEX).
• Cash flow forecast: A cash flow forecast, or CFF, can be calculated with the formula: Ending Cash = (Beginning Cash + Projected Cash Inflows) – Projected Cash Outflows. It partially overlaps with the indirect method for OCF because it anticipates future monies flowing through the accounts payable and accounts receivable departments.

Get the MasterClass Annual Membership for exclusive access to video lessons taught by business luminaries, including Chris Voss, Jeff Goodby & Rich Silverstein, Robin Roberts, Sara Blakely, Daniel Pink, Bob Iger, Howard Schultz, Anna Wintour, and more.