Cash Flow Statements: Reviewing Cash Flow From Operations (2024)

What Is Operating Cash Flow?

Operating cash flow is cash generated from the normal operating processes of a business. A company's ability to generate positive cash flows consistently from its daily business operations is highly valued by investors. In particular, operating cash flow can uncover a company's true profitability. It’s one of the purest measures of cash sources and uses.

The purpose of drawing up a cash flow statement is to see a company's sources and uses of cash over a specified time period. The cash flow statement is traditionally considered to be less important than the income statement and the balance sheet, but it can be used to understand the trends of a company's performance that can't be understood through the other two financial statements.

While the cash flow statement is considered the least important of the three financial statements, investors find the cash flow statement to be the most transparent. That's why they rely on it more than any other financial statement when making investment decisions.

Key Takeaways

  • Operating cash flow is cash generated from the normal operating processes of a business and can be found in the cash flow statement.
  • The cash flow statement is the least important financial statement but is also the most transparent.
  • The cash flow statement is broken down into three categories: Operating activities, investment activities, and financing activities.
  • Cash flow is calculated using the direct (drawing on income statementdata using cash receipts and disbursem*nts from operating activities) or the indirect method (starts withnet income, converting it to operating cash flow).
  • OCF helps investors gauge what's going on behind the scenes and is a better indicator of profitability than net income.

The Cash Flow Statement

Operating cash flow can be found in the cash flow statement,which reports the changes in cash compared to its static counterparts—the income statement, balance sheet, and shareholders’ equity statement. Also known as the cash flow from operations (CFO), it specifically reports where cash is used and generated over specific time periods, tying the static statements together.

By taking net income on the income statement and making adjustments to reflect changes in the working capital accounts on the balance sheet (receivables, payables, inventories) and other non-cash charges, the operating cash flow section shows how cash was generated during the period. It is this translation process from accrual accounting to cash accounting that makes the operating cash flow statement so important.

The cash flow statement is broken down into three categories. These are segregated so that analysts develop a clear idea of all the cash flows generated by a company’s various activities:

  • Cash flow from operating activities: This category records a company's operating cash movement, the net of which is where operating cash flow is derived.
  • Cash flow from investing activities: This category records changes in cash from the purchase or sale of property, plants, equipment (PP&E), or long-term investments.
  • Cash flow from financing activities: This category reports cash level changesfrom the purchase of a company’s own stock or issue of bonds and payments of interest and dividends to shareholders.

In some cases, there is a supplemental activities category as well. Supplemental information basically refers to anything else that does not relate to the other major categories.

Net income refers to the total sales minus the cost of goods sold and expenses related to sales, administration, operations, depreciation, interest, and taxes.

Breakdown of Activities

Operating activities are normal and core activities within a business that generate cash inflows and outflows. They include:

  • Total sales of goods and services collected during a period
  • Payments made to suppliers of goods and services used in production settled during a period
  • Payments to employees or other expenses made during a period

Cash flow from operating activities is anything it receives from its operations. This means it excludes money spent on capital expenditures, cash directed to long-term investments, and any cash received from the sale of long-term assets. Also excluded are the amounts paid out as dividends to stockholders, amounts received through the issuance of bonds and stock, and money used to redeem bonds.

Investing activities consist of payments made to purchase long-term assets, as well as cash received from the sale of long-term assets. Examples of investing activities are the purchase or sale of a fixed asset or property, plant, and equipment and the purchase or sale of a security issued by another entity.

Financing activities consist of activities that will alter the equity or borrowings of a company. Examples of financing activities include the sale of a company's shares or the repurchase of its shares.

Calculating Cash Flow

To see the importance of changes in operating cash flows, it’s important to understand how cash flowis calculated. Two methods are used to calculate cash flow from operating activities, both of which produce the same result:

  • Direct method: This method draws data from the income statement using cash receipts and cash disbursem*nts from operating activities. The net of the two values is the operating cash flow.
  • Indirect method: This method starts with net income and converts it to OCF by adjusting for items that were used to calculate net income but did not affect cash.

Cash Flow Statements: Reviewing Cash Flow From Operations (1)

Direct Method

The direct method adds up all the various types of cash payments and receipts, includingcash paid to suppliers, cash receipts from customers and cash paid out in salaries. These figures are calculated by using the beginning and ending balances of a variety of business accounts and examining the net decrease or increase of the account.

The exact formula used to calculate the inflows and outflows of the various accounts differs based on the type of account. In the most commonly used formulas, accounts receivables are used only for credit sales, and all sales are done on credit.

If cash sales also occur, receipts from cash sales must also be included to develop an accurate figure of cash flow from operating activities. Since the direct method does not include net income, it must also provide a reconciliation of net income to the net cash provided by operations.

Indirect Method

Under the indirect method, cash flow from operating activities is calculated by first taking the net income from a company's income statement.Because a company’s income statement is prepared on an accrual basis, revenue is only recognized when it is earned and not when it is received.

Net income is not a perfectly accurate representation of net cash flow from operating activities, so it becomes necessary to adjust earnings before interest and taxes (EBIT) for items that affect net income even though no actual cash has yet been received or paid against them. The indirect method also makes adjustments to add back non-operating activities that do not affect a company's operating cash flow.

Which Method Should You Use?

The direct method for calculating a company's cash flow from operating activities is a more straightforward approach in that it reveals a company's operating cash receipts and payments, but it is more challenging to prepare since the information is difficult to assemble. Still, whether you use the direct or indirect method for calculating cash from operations, the same result will be produced.

The image below shows reported cash flow activities for AT&T (T) forthe 2012 fiscal year. All figures reflected are in millions. Using the indirect method, each non-cash item is added back to net income to produce cash from operations. In this case, cash from operations is over five times as much as reported net income, making it a valuable tool for investors in evaluating AT&T's financial strength.

Cash Flow Statements: Reviewing Cash Flow From Operations (2)

Operating Cash Flows (OCF)

OCF is a prized measurement tool as it helps investors gauge what’s going on behind the scenes. For many investors and analysts, OCF is considered the cash version of net income, since it cleans the income statement of non-cash items and non-cash expenditures (depreciation, amortization, non-cash working capital items).

OCF is a more important gauge of profitability than net income as there is less opportunity to manipulate OCF to appear more or less profitable. With the passing of strict rules and regulations on how overly creative a company can be with its accounting practices, chronic earnings manipulation can easily be spotted, especially with the use of OCF. It is also a good proxy of a company’s net income. For instance, a reported OCF higher than NI is considered positive as income is actually understated due to the reduction of non-cash items.

The Bottom Line

Operating cash flow is just one component of a company’s cash flow story, but it is also one of the most valuable measures of strength, profitability, and the long-term future outlook. It is derived either directly or indirectly and measures money flow in and out of a company over specific periods.

Unlike net income, OCF excludes non-cash items like depreciation andamortization, which can misrepresent a company's actual financial position. It is a good sign when a company has strong operating cash flows with more cash coming in than going out. Companies with strong growth in OCF most likely have a more stable net income, better abilities to pay and increase dividends, and more opportunities to expand and weather downturns in the general economy or their industry.

If you think cash is king, strong cash flow from operations iswhat you should watch for when analyzing a company.

Cash Flow Statements: Reviewing Cash Flow From Operations (2024)


Cash Flow Statements: Reviewing Cash Flow From Operations? ›

Cash flow from operations is the section of a company's cash flow statement that represents the amount of cash a company generates (or consumes) from carrying out its operating activities over a period of time. Operating activities include generating revenue, paying expenses, and funding working capital.

How do you analyze cash flow from operating activities? ›

How Do You Calculate Cash Flow Analysis? A basic way to calculate cash flow is to sum up figures for current assets and subtract from that total current liabilities. Once you have a cash flow figure, you can use it to calculate various ratios (e.g., operating cash flow/net sales) for a more in-depth cash flow analysis.

What is cash flow from operations on cash flow statement? ›

Cash flow from operating activities (CFO) indicates the amount of money a company brings in from its ongoing, regular business activities, such as manufacturing and selling goods or providing a service to customers. It is the first section depicted on a company's cash flow statement.

What should I look for when reviewing a cash flow statement? ›

A statement of cash flow is divided in operating, investing, and financing sections. You can evaluate each section individually to better understand recurring and non-recurring activity. You can also evaluate the statement using cash flow per share, free cash flow, or cash flow to debt.

How do you calculate cash from operations in cash flow statement? ›

The cash flow from operations can be calculated in this way:
  1. Cash flow from operations = Funds from operations + changes in working capital.
  2. Funds in operations = Net income + depreciation + amortisation + deferred taxes + investment tax credit + other funds.
Sep 11, 2022

What are the 3 types of cash flow statement? ›

The three categories of cash flows are operating activities, investing activities, and financing activities. Operating activities include cash activities related to net income. Investing activities include cash activities related to noncurrent assets.

What is an example of cash flow analysis? ›

Let's say a company called Red Bikes has just opened and earned a net income of $75,000 to start and generated additional cash inflows of $95,000. Cash outflows (expenses like rent and payroll) totaled $25,925. This leaves an ending cash balance of $144,075.

Is cash flow from operations the same as operating cash flow? ›

Operating cash flow – also called cash flow from operating activities or cash flow provided by operations – refers to the capital that your business generates through its core business activities. It doesn't include expenses, revenue drawn from investments, or long-term capital expenditures.

Is cash flow from operations the same as total cash flow? ›

Total cash flow is the operative cash flow plus the net of the working capital of the company. The net of the working capital is the difference between assets and liabilities. The operative cash flow reports inflows and outflows as a result of regular operating activities.

What is an example of a negative cash flow from operating activities? ›

Negative cash flow is when your business has more outgoing than incoming money. You cannot cover your expenses from sales alone. Instead, you need money from investments and financing to make up the difference. For example, if you had $5,000 in revenue and $10,000 in expenses in April, you had negative cash flow.

How do you read and analyze cash flow statements? ›

To interpret your company's cash flow statement, start by looking at the inflows and outflows of cash for each category: operating activities, investing activities, and financing activities. If all three areas show positive cash flow, your business is likely doing well (although there are exceptions).

What is the most important thing on a cash flow statement? ›

Regardless of whether the direct or the indirect method is used, the operating section of the cash flow statement ends with net cash provided (used) by operating activities. This is the most important line item on the cash flow statement.

What are the common mistakes on the statement of cash flows? ›

One of the most common errors that businesses make in their cash flow statements is misclassifying how cash is actually flowing through their business. This results in a lot of confusion about where the cash is actually going, which can disrupt the actual cash flow of the business.

What is reconciliation of cash flows from operating activities? ›

Start your reconciliation with net income at the top. Add back the total value of noncash expenses to your operating cash flow. Next, subtract the period change for each category of current assets. Then, add the period change in each category of current liabilities.

What is the difference between funds from operations and cash from operations? ›

The FFO represents the operating performance and takes net income, depreciation, amortization, and losses on property sales into account while factoring out any interest income and gains from property sales. The cash flow from operations, on the other hand, is reported on the cash flow statement.

Where is cash flow from operations? ›

You can find the cash flow from operating activities on a company's cash flow statement. This section normally appears at the top of the statement. You can also calculate operating cash flow by adding together a company's net income, non-cash items (adjustments to net income), and working capital.

Where does cash flow from operating activities go? ›

Cash outflows (payments) from operating activities include:

Cash payments to acquire materials for providing services and manufacturing goods for resale. Cash payments to employees for services. Cash payments considered to be operating activities of the grantor. Cash payments for quasi-external operating transactions.

What cash flows from operating activities might include? ›

Activities that might result in cash flow from operating activities include: Sales transactions. Cash payments received. Tax payments.

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