What is Operating Cash Flow?
Operating Cash Flow (OCF) is cash relating to core business activities over time. Ideally, the money coming into the business generated from your service offering (i.e. sales) should be more than operating costs.
OCF is used to evaluate the underlying health of the business and to demonstrate the cash generated from normal operations without taking into account secondary sources of revenue, such as investments, finance or the sale of assets.
Operating activities explained
The various sources and applications of cash included in your OCF are directly related to providing your goods and services to the market. These include but are not limited to:
- Receipts from sales
- Payments made to suppliers
- Tax payments (GST and PAYG)
- Any interest payments or finance costs
- Employee wages (including PAYG)
- Rent for business property
- and any other income or expenses relating to a company’s daily activities, such as overheads, fuel tax credits, etc.
- How to calculate Operating Cash Flow
Your business can typically generate cash from three sources: normal operating activities, cash injected from investing (equity, shareholders), and cash from financing (debt).
OCF is calculated by adding Net Income (revenue – the cost of sales) to Noncash Expenses (typically depreciation) plus changes in working capital (debtors, creditors, stock, cost of goods and work in progress).
OCF = Net Income + Noncash Expenses + Change in Working Capital
Net Income: The amount of revenue left after the cost of sales, fewer expenses, and other deductions are taken out.
Noncash Expenses: An accounting expense, such as depreciation, amortisation, movement in asset values, stock-based compensation, and asset impairments.
Change in working capital: the change in current assets (cash in the bank, debtors, stock and work in progress) minus the current liabilities (creditors, tax).
Note: Collection of debtors is crucial. You can assume regular trading terms; however, the collection of invoices is often delayed.
Purpose of Operating Cash Flow
Cash flow and adequate working capital are what keep the business going. They allow you to pay obligations and commitments when they fall due and to invest in your business’s growth.
Without positive cash flow, businesses must source cash from other sources such as those mentioned above (equity or finance).
Having a negative OCF occasionally is ok. Still, if you continue on a negative path over consecutive months/years, you’re using cash from equity or financing activities to pay for your losses.
Over time, this will have a huge impact on your business and may even force you to make tough decisions, such as closing the doors or becoming insolvent.
It’s important to note that OCF should not be used as an overall financial analysis of the business; instead, it should be used with other metrics to ensure an accurate understanding of the business.
Benefits of understanding your business’ Operating Cash Flow
- Allows you to understand your core business’s profitability, strengths and weaknesses
- It allows you to understand the long-term outlook of your business so you can forecast and budget
- A positive OCF enable you to attract further equity or will give you confidence to invest further in your business
Manage your Operating Cash Flow with a well-structured 3-way forecast
If you’re unsure of your business’s performance, especially during these uncertain times, know you’re not alone. A well-structured 3-way forecast and a full understanding of your business’s cash flow are more important than ever.
At Ledge, we have several trusted strategic partners who can analyse your business and formulate a 3-way forecast, which considers your cash flow, balance sheet and profit and loss statement, to create a financial forecast suited to your business.
If this article has sparked questions about your business’s OCF and overall performance, please contact your Ledge Finance Executive directly or our offices here. We will do our best to assist you through these challenging times.
