Operating Cash Flow: Why This Formula Is Paramount to Your Business

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Do you own a business with less than 15 million in revenue? As a business owner, you must understand how cash flows in and out of your small or medium-sized business to ensure financial stability and avoid a pitfall that’s common among startups in particular: running out of money.

Fortunately, taking your business’s financial pulse proves as simple as calculating your operating cash flow (OCF). Unfortunately, many business owners don’t understand what OCF is, let alone how to find it. 

What are the different types of cash flow?

Two types of cash flow influence a business’s financials:

  1. Non-operating cash flow, or investing cash flow, refers to a company’s investments. Many business owners and owner-operators find calculating this number to be simple because you know whether you’re buying a building or investing in a piece of equipment.
  2. Operating cash flow encompasses cash flow from operating activities, including accounts payable (AP), accounts receivable (AR), net income, and non-cash operating expenses. Owners must calculate OCF to understand how money moves through the business within a given time period.

Non-operating cash flow is typically known by an organization where operating cash flow often isn’t.

What is operating cash flow (OCF)?

The operating cash flow measure refers to how much cash the organization generates within a given period of time, usually a month. It’s what you need to know to run your organization successfully. Understanding your OCF helps you remain solvent and able to pay obligations like payroll and vendors while also taking care of your customers.

Why is operating cash flow important?

Knowing your OCF proves vital for business success for many reasons. Let’s explore a few of them. 

  1. How can I use operating cash flow in my business?

By understanding your OCF, you can appreciate the long-term cash needs of your business or organization. While you can postpone non-operating cash flow needs, you must maintain your operating income to function as a business. 

For example, your cash flow may look very skewed if your AR number has significantly increased for a particular month, but you may be able to push out the payables to extend your cash flow for that month. 

  1. How can understanding my operating cash flow help me make decisions?

When you look at your OCF, you get a more comprehensive picture of your business financials compared to only looking at the profit & loss (P&L) statement or balance sheet. The latter won’t show you if you have a large tax payment due or a high AR. By understanding your operating cash flow, you can make operating decisions based on the complete picture instead of just part of it. 

  1. Are there decisions I should NOT make if I don’t know my operating cash flow?

Knowing your operating cash flow allows you to make more educated financial decisions for your business. The P&L may show you your net income, but it doesn’t provide a clear overall picture of what’s happening.

The only decision you should not be making is neglecting to get educated either through helpful articles like this one or by seeking expert advice from professionals. 

How do I calculate my operating cash flow?

To calculate operating cash flow, use the following formula:

OCF = net income + non-cash expenses + change in working capital

So, as an example, your business’s formula may look like this:

OCF = net income – taxes + depreciation + other non-cash items – increase in AR + increase in AP

You can find these numbers on your business’s financial statements.

What information do I need to determine my operating cash flow accurately?

To help you create your business’s formula, let’s expand a bit on the information you need to accurately calculate operating cash flow:

  • Net income refers to your business revenues minus taxes, expenses, and interest. You can find this number at the bottom of your income statement. 
  • Non-cash items refer to income statement expenses that don’t have cash payments. These include capital depreciation, investment losses and gains, and deferred income tax. These items don’t affect the cash balance, so they are added back in. 
  • Changes in working capital refer to adjustments in operating liabilities and current assets, including changes in inventory, AP, and AR. For example, when your AP number increases, so too does your cash flow, and when your inventory increases, your cash flow decreases. All of these adjustments must go into the operating cash flow formula for an accurate result.

Consider the following example statement of cash flow: (This is a very simplified example with arbitrary numbers. Your formula may include additional expenses.)

  • Net income: $3,000
  • Property and Equipment depreciation: $10,000
  • Deferred income taxes: – $100
  • Other non-cash expenses: $200
  • Increase in Inventory: – $3,000
  • Increase in accounts receivable: $4,000
  • Increase in accounts payable: $8,000

OCF = $3,000 + $10,000 – $100 + $200 – $3,000 – $4,000 + $8,000 = $14,100

Who can help me calculate my operating cash flow?

Many finance professionals can help you with cash flow calculations and other helpful figures, including a cash flow forecast and free cash flow number. Such professionals include bookkeepers, certified public accountants (CPAs), and other financial experts.

If you need help understanding the cash flow for your small to medium-size business, consider reaching out to our accounting professionals at Margin Authority. We provide financial expertise to help clients optimize their cash flows.

At Margin Authority, We Are Here To Be Your Fractional CFO

At Margin Authority, our team can help you manage the cash flow of your business to ensure its financial health. We’ll help you generate a higher cash flow by presenting the big picture of your business’s finances and providing actionable insight to help you grow.

We’ll likely start by looking at your break-even and adjusting your cash flow to help you get there. 

If you need temporary help to combat the current recession and inflation pressures, we can provide fractional CFO services to help you navigate the choppy waters of the present economy and improve your financial performance.

At Margin Authority, we have a history of success in helping businesses generate cash and strengthen their business valuations. Get in touch with us today to learn more about operating cash flow and how we can help you reach financial success in your business.Call us at 330-696-4133 or fill out our convenient online contact form to ensure you have a clear picture of your business’s finances today!

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