Operating Cash Flow is one of the most important metrics for a business, but few track it.
So what is it and what does it mean?
Let’s dig in.
So what is it and what does it mean?
Let’s dig in.
Simply defined, Operating Cash Flow is the cash generated from operations.
The formula is:
Net Income
+/- Adjustments to Income
+/- Changes in Working Capital
What do these mean?
The formula is:
Net Income
+/- Adjustments to Income
+/- Changes in Working Capital
What do these mean?
+/- Adjustments to Income
In the Income Statement, non-cash expenses decrease net income, thus clouding cash flow from operations.
Common Non-Cash Expenses are:
- Depreciation & Amortization
- Stock-based compensation
- Unrealized gain or loss
- Deferred income taxes
In the Income Statement, non-cash expenses decrease net income, thus clouding cash flow from operations.
Common Non-Cash Expenses are:
- Depreciation & Amortization
- Stock-based compensation
- Unrealized gain or loss
- Deferred income taxes
+/- Changes in Working Capital
In the Balance Sheet, changes in Currents Assets & Liabilities are real changes in cash.
Your Accounts Receivable went up? That is unreceived cash which means it’s unreceived Income.
That would decrease cash flow from Operations.
In the Balance Sheet, changes in Currents Assets & Liabilities are real changes in cash.
Your Accounts Receivable went up? That is unreceived cash which means it’s unreceived Income.
That would decrease cash flow from Operations.
Examples of accounts that affect Working Capital:
- Inventory
- Accounts Receivable
- Accounts Payable
- Other Current Assets or Liabilities
- Inventory
- Accounts Receivable
- Accounts Payable
- Other Current Assets or Liabilities
Whether your Operating Cash Flow is healthy is dependent on your situation.
Even so, here are 4 questions you can ask about your Operating Cash Flow:
Even so, here are 4 questions you can ask about your Operating Cash Flow:
1) Is it positive?
Positive means you’re generating cash from operations.
If it’s negative, you need to figure out why it’s negative.
It can be temporarily negative, but it shouldn’t stay that way.
Positive means you’re generating cash from operations.
If it’s negative, you need to figure out why it’s negative.
It can be temporarily negative, but it shouldn’t stay that way.
2) Is it greater than net profit?
Profit is reduced by depreciation and non-cash charges, so OCF should naturally be bigger than profit.
If not, you need to understand why.
That means you’re not turning profit into cash (Badddd).
Profit is reduced by depreciation and non-cash charges, so OCF should naturally be bigger than profit.
If not, you need to understand why.
That means you’re not turning profit into cash (Badddd).
3) Is it greater than new fixed asset purchases?
It's good to reinvest, but not if eats up all your cash.
It’s generally healthier to fund investments with operating cash versus financing, as you save in interest expense.
This is Free Cash Flow, another valuable metric.
It's good to reinvest, but not if eats up all your cash.
It’s generally healthier to fund investments with operating cash versus financing, as you save in interest expense.
This is Free Cash Flow, another valuable metric.
4) Is it trending in the same way as profits?
Look at the last three years’ profits compared to operating cash flow.
Is OCF shrinking or growing comparatively?
This will highlight if you’ve become more or less efficient with your dollars.
Look at the last three years’ profits compared to operating cash flow.
Is OCF shrinking or growing comparatively?
This will highlight if you’ve become more or less efficient with your dollars.
This is just a primer, but hopefully it was helpful.
If you have questions about this concept, feel free to ask in the comments.
I'd love to help!
If you have questions about this concept, feel free to ask in the comments.
I'd love to help!
Are you an entrepreneur or business leader?
Financial literacy is one of the most important skills you can learn.
Each Thursday I teach 1 financial concept (similar to this thread) to 10,000+ on my newsletter.
Join them here:
newsletter.kurtishanni.com
Financial literacy is one of the most important skills you can learn.
Each Thursday I teach 1 financial concept (similar to this thread) to 10,000+ on my newsletter.
Join them here:
newsletter.kurtishanni.com
To those say "everyone tracks this."
I 100% agree it's common to track in the finance profession.
But I think we're seeing false-consensus bias at play here.
But most business owners I speak to have never looked at a Statement of Cash Flows and definitely can't read it.
I 100% agree it's common to track in the finance profession.
But I think we're seeing false-consensus bias at play here.
But most business owners I speak to have never looked at a Statement of Cash Flows and definitely can't read it.
Loading suggestions...