What is Operating Cash Flow?

John Lister

Operating cash flow is an accounting concept. Fundamentally it is the amount of cash generated by the trading activities of a business. It will usually be the first item listed in the cash flow section of a set of company accounts, mainly because it is the simplest figure in that section.

Man climbing a rope
Man climbing a rope

In its simplest form, operating cash flow is simply a record of the money which goes into and out of the company. Money paid in includes sales revenues and any money owed by customers which isn’t received by the end of the accounting year. Money paid out includes the direct costs of producing products, such as raw materials and labor costs, and any money owed to suppliers which isn’t received by the end of the year. However, these expenses don’t include general costs such as capital expenditure or marketing.

In the United States, operating cash flow generally also includes depreciation. This is a measure of how assets owned by a company have lost their value. In manufacturing, a key example would be machinery getting older. Some of the money which was spent on buying the machinery will never be recoverable by selling it on. Depreciation doesn’t take any account of whether or not the firm ever intends to sell the asset: it is simply an accounting method to take account of this “cost” over the life of the asset.

Looking at both the operating cash flow and the actual profit on a set of company accounts can be very revealing. The difference between the two numbers, and the details of how they differ, can reveal some fundamental problems with a company’s structure or operation. For example, a firm may be turning a profit but be crippled by capital expenditure such as replacing machinery or be spending too much on marketing.

It’s arguable that operating cash flow can be one of the most illuminating figures in company accounts. This is partly because it is difficult to manipulate: other than pushing back purchases or sales at the end of one financial year so that they are instead recorded for the following year, the only real way to change the figure is to lie. It is also a useful snapshot of whether a business is fundamentally profitable. However, examination of the full accounts is needed to find out how long a loss-making firm can survive the losses, or whether a firm turning a profit is doing so quickly enough to pay off long-term debts.

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