Operating Cash Flow (OCF): Definition, Types, and Formula (2024)

What Is the Operating Cash Flow Ratio?

The operating cash flow ratio is a measure of how readily current liabilities are covered by the cash flows generated from a company's operations. This ratio can help gauge a company's liquidity in the short term.

Using cash flow as opposed to net income is considered a cleaner or more accurate measure since earnings are more easily manipulated.

Key Takeaways

  • The operating cash flow ratio indicates if a company's normal operations are sufficient to cover its near-term obligations.
  • A higher ratio means that a company has generated more cash in a period than what was immediately needed to pay off current liabilities.
  • Cash flow from operations (CFO) is preferred over net income because there is less room to manipulate results through accounting tricks.

Operating Cash Flow (OCF): Definition, Types, and Formula (1)

The Formula for the Operating Cash Flow Ratio

Operatingcashflowratio=OperatingcashflowCurrentliabilities\text{Operating cash flow ratio} = \frac {\text{Operating cash flow}}{\text{Current liabilities}}Operatingcashflowratio=CurrentliabilitiesOperatingcashflow

The operating cash flow ratio is calculated by dividing operating cash flow by current liabilities. Operating cash flow is the cash generated by a company's normal business operations.

Operating Cash Flow Ratio Components

A company generates revenues—and deducts the cost of goods sold (COGS) and other associated operating expenses, such as attorney fees and utilities, from those revenues. Cash flow from operations is the cash equivalent of net income. It is the cash flow after operating expenses have been deducted and before the commencement of new investments or financing activities.

Investors tend to prefer reviewing the cash flow from operations over net income because there is less room to manipulate results. However, together, cash flows from operations and net income can provide a good indication of the quality of a firm's earnings.

Current liabilities are all liabilities due within one fiscal year (FY) or operating cycle, whichever is longer. They are found on the balance sheet and are typically regarded as liabilities due within one year.

Understanding the Operating Cash Flow Ratio

The operating cash flow ratio is a measure of the number of times a company can pay off current debts with cash generated within the same period. A high number, greater than one, indicates that a company has generated more cash in a period than what is needed to pay off its current liabilities.

An operating cash flow ratio of less than one indicates the opposite—the firm has not generated enough cash to cover its current liabilities. To investors and analysts, a low ratio could mean that the firm needs more capital.

However, there could be many interpretations, not all of which point to poor financial health. For example, a firm may embark on a project that compromises cash flows temporarily but renders substantial rewards in the future.

The Operating Cash Flow Ratio vs. the Current Ratio

Both the operating cash flow ratio and the current ratio measure a company’s ability to pay short-term debts and obligations.

The operating cash flow ratio assumes cash flow from operations will be used to pay those current obligations (i.e., current liabilities). The current ratio, meanwhile, assumes current assets will be used.

Example of the Operating Cash Flow Ratio

Consider two giants in the retail space, Walmart and Target. As of Feb. 27, 2019, the two had current liabilities of $77.5 billion and $17.6 billion, respectively. Over the trailing 12 months, Walmart had generated $27.8 billion in operating cash flow, while Target generated $6 billion.

The operating cash flow ratio for Walmart is 0.36, or $27.8 billion divided by $77.5 billion. Target’s operating cash flow ratio works out to 0.34, or $6 billion divided by $17.6 billion. The two had similar ratios, meaning they had similar liquidity. Digging deeper, we find that the two also shared similar current ratios as well, further validating that they indeed had similar liquidity profiles.

Limitations of Using the Operating Cash Flow Ratio

Although not as prevalent as with net income, companies can manipulate operating cash flow ratios. Some companies deduct depreciation expenses from revenue even though it does not represent a real outflow of cash.

Depreciation expense is an accounting convention that is meant to write off the value of assets over time. As a result, companies should add depreciation back to cash in cash flow from operations.

Operating Cash Flow (OCF): Definition, Types, and Formula (2024)


Operating Cash Flow (OCF): Definition, Types, and Formula? ›

Operating cash flow formula

How do you calculate operating cash flow or OCF? ›

The simplest formula goes like this:
  1. Operating cash flow = total cash received for sales - cash paid for operating expenses.
  2. OCF = (revenue - operating expenses) + depreciation - income taxes - change in working capital.
  3. OCF = net income + depreciation - change in working capital.

What is the formula for operating cash flow? ›

Because most companies report the net income on an accrual basis, it includes various non-cash items, such as depreciation and amortization. Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital.

What is the OCF of the cash flow statement? ›

Operating Cash Flow (OCF) is the amount of cash generated by the regular operating activities of a business within a specific time period.

What is the formula for the operating cash flow direct method? ›

Formulas of the Direct Method

Cash Received from Customers = Sales + Decrease (or - Increase) in Accounts Receivable. Cash Paid for Operating Expenses (Includes Research and Development) = Operating Expenses + Increase (or - decrease) in prepaid expenses + decrease (or - increase) in accrued liabilities.

What is operating cash flow quizlet? ›

Operating cash flow is defined as: a firm's net profit over a specified period of time.

What is the operating cash flow to operating profit? ›

Operating cash flow FAQ

Operating profit includes depreciation and amortization, but excludes interest and taxes. Cash flow from operations does the opposite: it excludes depreciation and amortization because they are non-cash expenses, and it includes interest and taxes because they are cash expenses.

What is the formula to calculate operating cash flow with indirect method? ›

Cash flow from operating activities = Net income + depreciation expense + decrease in accounts receivables – increase in inventory + increase in accounts payable. Net income, depreciation expense, decrease in AR, and increase in AP are cash inflows. Hence they need to be added.

How do you calculate free cash flow? ›

What is the Free Cash Flow (FCF) Formula? The generic Free Cash Flow (FCF) Formula is equal to Cash from Operations minus Capital Expenditures. FCF represents the amount of cash generated by a business, after accounting for reinvestment in non-current capital assets by the company.

Is operating cash flow the same as free cash flow? ›

Operating cash flow measures cash generated by a company's business operations. Free cash flow is the cash that a company generates from its business operations after subtracting capital expenditures. Operating cash flow tells investors whether a company has enough cash flow to pay its bills.

How to calculate operating cash flow ratio from balance sheet? ›

Operational cash flow ratio is computed by dividing cash flow resulting from core operations by the firm's current liabilities.

Top Articles
Latest Posts
Article information

Author: Chrissy Homenick

Last Updated:

Views: 5533

Rating: 4.3 / 5 (74 voted)

Reviews: 89% of readers found this page helpful

Author information

Name: Chrissy Homenick

Birthday: 2001-10-22

Address: 611 Kuhn Oval, Feltonbury, NY 02783-3818

Phone: +96619177651654

Job: Mining Representative

Hobby: amateur radio, Sculling, Knife making, Gardening, Watching movies, Gunsmithing, Video gaming

Introduction: My name is Chrissy Homenick, I am a tender, funny, determined, tender, glorious, fancy, enthusiastic person who loves writing and wants to share my knowledge and understanding with you.