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Operating Cash Flow (OCF)

Updated: Apr 26

Operating cash flow (OCF) is a measure of the amount of cash generated by a company's normal business operations. Operating cash flow indicates whether a company can generate sufficient positive cash flow to maintain and grow its operations, otherwise, it may require external financing for capital expansion.


Two methods of presenting the operating cash flow section are acceptable under generally accepted accounting principles (GAAP)-the indirect method or the direct method. However, if the direct method is used, the company must still perform a separate reconciliation to the indirect method.


Indirect Method

Using the indirect method, net income is adjusted to a cash basis using changes in non-cash accounts, such as depreciation, accounts receivable (AR), and accounts payable (AP). Because most companies report the net income on an accrual basis, it includes various non-cash items, such as depreciation and amortization.

The calculation for OCF using the indirect method uses the following formula:


OCF = NI + D&A - NWC


where:

  • NI = company's net income

  • D&A = depreciation and amortization

  • NWC = increase in net working capital


Direct Method

The second option is the direct method, in which a company records all transactions on a cash basis and displays the information using actual cash inflows and outflows during the accounting period. Examples of items included in the presentation of the direct method of operating cash flow include:

  • Salaries paid out to employees

  • Cash paid to vendors and suppliers

  • Cash collected from customers

  • Interest income and dividends received

  • Income tax paid and interest paid

This method is simpler than the indirect method because there are fewer factors to consider. However, it only accounts for cash revenues and expenses. It is calculated with the formula:


OCF = Cash Revenue - Operating Expenses Paid in Cash


Source: Investopedia, Operating Cash Flow (OCF): Definition, Cash Flow Statements, accessed 25 December 2023, <https://www.investopedia.com/terms/o/operatingcashflow.asp>

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