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Operating Cash Flow

A measure of the amount of money made by a company's regular business operations is called operating cash flow (OCF). Operational cash flow shows if a business can produce enough positive cash flow to support and expand its operations; if not, it may need outside finance for capital growth.

Understanding Operating Cash Flow (OCF)

Operating cash flow is a measure of a company's net income (NI) from its primary business operations. Operating cash flow, also known as cash flow from operational operations, is the first section of the cash flow statement.

Both the indirect method and the direct method are valid ways to show the operating cash flow section in accordance with generally accepted accounting principles (GAAP). The business must nevertheless carry out a separate reconciliation to the indirect approach even if the direct method is employed.

Importance of Operating Cash Flow

According to generally accepted accounting principles (GAAP), either the indirect method or the direct method can be used to depict the operating cash flow section. Yet even if the direct approach is taken, the business must still carry out a separate reconciliation to the indirect approach.

For instance, making a substantial transaction boosts revenue significantly, but if the company is having problems getting paid, it is not really advantageous. On the other hand, if a corporation has a lot of fixed assets and employs accelerated depreciation estimates, it may have significant levels of operating cash flow but report a relatively low net income.

If a company's main business operations aren't generating enough revenue, it will need to obtain short-term external funding sources through investing or financing. On the other hand, this is not long-term sustainable. As a result, operating cash flow is a crucial indicator of the operational financial soundness of a corporation.

How to Calculate Operating Cash Flow

Indirect Method

Using the indirect approach, changes in non-cash accounts like depreciation, accounts receivable (AR), and accounts payable are used to convert net income to a cash basis (AP). Depreciation and amortization are just two examples of the several non-cash items that are included in net income because most businesses report it on an accrual basis.

The following formula is used to calculate OCF using the indirect method:

OCF = NI + D&A - NWC

In this equation, NI stands for net income, D&A for depreciation and amortization, and NWC for net working capital growth.

Direct Method

The second choice is the direct approach, in which a business keeps a cash record of every transaction and presents the data using actual cash inflows and outflows over the course of the accounting period. Examples of things shown in the direct technique of operating cash flow presentation include:

  1. Wages provided to employees
  2. Amounts paid to suppliers and vendors
  3. Money received from clients
  4. Dividends and interest received
  5. Paid income taxes and interest

Because there are fewer variables to take into account, this method is easier than the indirect method. Yet, it simply takes into account monetary receipts and outlays. The formula is used to compute it:

OCF = Cash Revenue - Operating Expenses Paid in Cash


  • Operating cash flow is a crucial statistic for evaluating the financial health of a company's core business operations.
  • Operating cash flow is shown in the opening portion of a cash flow statement along with cash from financing and investing operations.
  • The indirect method and the direct approach are both ways to show operating cash flow on a cash flow statement.
  • The indirect method begins with the net income reported on the income statement and deducts non-cash items to arrive at the cash base amount.
  • The direct method tracks all transactions in a period on a cash basis and reports actual cash inflows and outflows on the cash flow statement.
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