How Business Owners Can Calculate Operating Cash Flow: Explanation + Formula

Published: November 7, 2023, Last Updated: February 2, 2024

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Writer: Martha Pierson
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A striking 82% of small businesses collapse due to mismanaged cash flow, not lack of profit. What, then, is the essence of operating cash flow? In this exploration, we’ll dissect cash flow analysis and provide you with the tools to adeptly calculate operating cash flow, fortifying your business against financial pitfalls.

What is Operating Cash Flow?

Operating cash flow (OCF) is the money produced by a company’s day-to-day operations, reflecting its ability to maintain and grow its operations. It represents the cash that flows in and out of a business from its core operations, such as sales, inventory purchases, payment of wages, and taxes. OCF is a key financial metric used by analysts, investors, and management to evaluate a company’s financial health and performance.

Business professional looking at virtual financial report

The main components of operating cash flow are revenues and expenses. Revenue represents the cash generated from sales, while expenses include all the costs associated with running the business, such as salaries, rent, utilities, and supplies. It does not include investments or interest.

For instance, if a retail store earns $700,000 in sales revenue and has operating expenses totaling $500,000, its OCF would be $200,000 ($700,000 revenue – $500,000 expenses).

Operating Cash Flow vs. Free Cash Flow vs. Net Cash Flow

Understanding your company’s financial health goes beyond glancing at the bottom line. It involves dissecting key financial metrics, each offering a unique lens through which to view your business’s viability and stability. Let’s explore three pivotal metrics – Operating Cash Flow, Free Cash Flow, and Net Cash Flow – to equip you with the insights needed to steer your business effectively.

Operating Cash Flow (OCF)

  • Definition: Represents the cash generated from a company’s core business operations, excluding non-operating activities.
  • Example: A company generates $1 million in cash from production and sales and pays $600,000 in operating expenses. Thus, OCF = $400,000.
  • Significance: Indicates the efficiency of a company’s operations and its ability to generate positive cash flow.

A robust OCF can indicate operational efficiency and self-sustainability.

Free Cash Flow (FCF)

  • Definition: Takes OCF a step further by subtracting capital expenditures (CapEx).
  • Example: With $200,000 in CapEx, FCF = $200,000 ($400,000 OCF – $200,000 CapEx).
  • Significance: Measures available cash for reinvestment or distribution after accounting for maintenance or expansion costs.

FCF is often spotlighted when evaluating a company’s ability to expand or provide shareholder value.

Net Cash Flow (NCF)

  • Definition: The total of cash inflows and outflows from all company activities within a specified period.
  • Example: NCF = $350,000 ($400,000 OCF + $50,000 investing cash inflow – $100,000 financing cash outflow).
  • Significance: Offers a comprehensive view of a company’s liquidity and is pivotal for assessing short-term solvency.

NCF helps businesses evaluate their liquidity and make informed financial decisions.

Why Operating Cash Flow Is Important for Businesses

Operating cash flow provides a snapshot of the company’s ability to generate revenue from its core operations, which is an indicator of its financial health. This metric is also often used to assess a company’s ability to cover its ongoing expenses and invest in growth opportunities.

Business professionals discussing cash flow

Here’s a sum up of insights operating cash flow provides:

  • Solvency: A positive operating cash flow ensures that a business can pay its bills and debts on time, maintaining a good credit standing and avoiding financial turmoil.
  • Growth Potential: By keeping a close eye on operating cash flow, business owners can identify opportunities to expand and invest in new ventures, ultimately driving growth and increasing profitability.
  • Investor Confidence: Strong operating cash flow signals to investors that a company is financially stable and well-positioned for success, potentially attracting more investment and support.
  • Cash Flow Forecasting: Accurate operating cash flow analysis enables businesses to create more realistic cash flow projections, allowing them to plan for future expenses and anticipate potential financial challenges.

Operating Cash Flow vs. Net Income vs. Earnings Per Share

Operating cash flow (OCF), net income, and earnings per share (EPS) are three distinct financial metrics that business owners and financial departments should evaluate to understand performance and profitability.

Operating Cash FlowMeasures the cash generated by a company’s day-to-day activities    Net Income + Depreciation and Amortization – Taxes +/- Changes in Working Capital  
Net IncomeMeasures a company’s profit or loss after all expenses have been deducted from revenueRevenue – Expenses
Earnings Per ShareMeasures the amount of profit earned per outstanding share of a company’s stockNet Income / Number of Outstanding Shares

As previously discussed, operating cash flow represents the cash generated from a company’s core business operations, highlighting the efficiency and financial stability of the firm.

For example, a restaurant with a steady OCF generates enough cash to cover its operating expenses, such as wages, rent, and inventory costs.

On the other hand, net income is the total profit or loss after accounting for all revenues, expenses, and taxes.

Suppose a retail store has $1 million in revenue, $700,000 in expenses, and $50,000 in taxes; its net income would be $250,000 ($1 million revenue – $700,000 expenses – $50,000 taxes). This metric evaluates a business’s overall profitability, considering operating and non-operating activities.

Earnings per share (EPS) is calculated by dividing the company’s net income by the number of outstanding shares of its common stock.

For instance, if a tech company has a net income of $2 million and 1 million outstanding shares, its EPS would be $2 ($2 million net income / 1 million shares). EPS is an indicator of a company’s profitability on a per-share basis and is particularly useful for investors when comparing the performance of different companies within the same industry.

Each of these metrics serves a unique purpose, and the preference for one over the others depends on the specific objectives of the business owner or financial department.

For instance, net income and earnings per share might be more appropriate if the goal is to analyze overall profitability or compare performance against industry peers.

How To Calculate Operating Cash Flow

Operating cash flow can be calculated using either the direct or indirect formula.

Close up on business balance sheet and calculator

Below is a breakdown of each method:

Direct Formula

The direct formula for calculating operating cash flow involves directly analyzing revenue and expenses related to a company’s business activities. The direct formula is:

Operating Cash Flow = Total Revenues – Operating Expenses

To calculate operating cash flow using the direct formula, follow these steps:

  1. Identify Cash Inflows: Compile a comprehensive list of all receipts, including cash sales, credit sales, and other revenue inflows associated with operating activities.
  2. Identify Cash Outflows: Gather information on all expenses related to operating activities, such as payments to suppliers, wages and salaries, rent, utilities, and other operating costs.
  3. Calculate Net Cash Flow: Subtract the total expenses from the total revenue to obtain the operating cash flow.

Let’s consider a specific example of calculating OCF using the direct formula. Suppose a retail store has the following cash transactions during a financial period:


  • Cash sales: $300,000
  • Credit sales: $200,000


  • Payments to suppliers: $250,000
  • Wages and salaries: $150,000
  • Rent: $30,000
  • Utilities: $20,000

Using the direct formula, we calculate the operating cash flow as follows:

Total revenue = $300,000 (cash sales) + $200,000 (credit sales) = $500,000

Total expenses = $250,000 (payments to suppliers) + $150,000 (wages and salaries) + $30,000 (rent) + $20,000 (utilities) = $450,000

Operating cash flow = $500,000 (total revenue) – $450,000 (total expenses) = $50,000

Indirect Formula

The indirect method for calculating operating cash flow involves starting with net income and adjusting for depreciation and changes in working capital. Here’s the formula:

Operating Cash Flow = Net Income + Depreciation and Amortization +/– Changes in Working Capital

To calculate operating cash flow using the indirect formula, follow these steps:

  1. Start with Net Income: Obtain the net income figure from the company’s income statement.
  2. Add Non-Cash Expenses: Identify and add non-cash expenses, such as depreciation and amortization, to the net income figure.
  3. Adjust for Changes in Working Capital: Analyze changes in working capital accounts, such as accounts receivable, inventory, and accounts payable. If current assets increase, subtract the change; if they decrease, add the change. If current liabilities increase, add the change; if they decrease, subtract the change.
  4. Calculate Operating Cash Flow: Combine the adjusted net income and changes in working capital to arrive at the operating cash flow.

Let’s consider a specific example of calculating OCF using the indirect formula. Suppose a manufacturing company has the following financial data for a given period:

  • Net income: $120,000
  • Depreciation expense: $30,000
  • Increase in accounts receivable: $10,000
  • Decrease in inventory: $5,000
  • Increase in accounts payable: $8,000

Using the indirect formula, we calculate the operating cash flow as follows:

Adjusted net income = $120,000 (net income) + $30,000 (depreciation) = $150,000

Changes in working capital = $5,000 + $8,000 – $10,000 = $3,000

Operating cash flow = $150,000 (adjusted net income) + $3,000 (changes in working capital) = $153,000

Professional business meeting discussing cash flow

So, when should you use one method over the other?

The direct method is more suitable for businesses that want to closely monitor specific cash transactions related to their core operations, while the indirect method is better for those who need an overview of how net income is converted into operating cash flow.

For instance, let’s say you own a small retail store and are interested in closely monitoring the impact of cash sales, credit sales, and individual operating expenses on your cash flow.

In this case, the direct method would be more suitable as it focuses on specific cash transactions. This approach will allow you to understand the cash collected from customers, payments made to suppliers, wages, and other operating expenses, offering you detailed insights into the revenue generated and used in your daily operations.

On the other hand, if you are the CFO of a large manufacturing company, your primary concern might be to understand the overall cash flow generated from your operations and its relationship with your net income.

In this scenario, the indirect method is preferable as it starts with net income and adjusts for non-cash expenses and changes in working capital. This method provides a big-picture view of how much of your net income is being converted into cash flow from operations without requiring a detailed analysis of individual transactions.

Bottom Line

Operating cash flow measures a company’s ability to sustain its operations over time. It can help businesses identify potential cash flow issues and investment opportunities. There are two formulas for calculating operating cash flow: direct and indirect.

Martha Pierson

Content CreatorMartha Pierson is a marketing strategist and business development expert based in Glendale, California. As a content creator for the Finturf blog, Martha shares her vast knowledge and experience with readers to help them build and sustain successful businesses. Her articles offer practical tips and actionable advice that entrepreneurs can implement immediately to achieve their goals. Martha also provides insightful analysis of current trends across different industries and offers expert guidance on how businesses can adapt to changing market conditions.

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