What is cash flow?
Cash flow is one of the most important metrics used by investors and analysts to evaluate financial health and business growth.
The term “cash flow” refers to the amount of cash generated by a company’s ongoing operations.
The 3 types of cash flows
Cash flows are important because they tell you how much money is coming into and out of a company. They help companies plan their budgets and determine whether they are making enough profit to pay off debts. Here are the three different kinds of cash flows included in the cash flow statement:
Operating cash flow: This refers to the total amount of money generated by a business’s normal business operations.
Investing cash flow: This includes specifically the cash invested in purchasing capital assets and investments in other business ventures.
Financing cash flow: This is the cash used to repay loans and interest owed to lenders plus dividends paid to shareholders.
Operating cash flow (OCF) definition
Operating cash flow is a KPI that measures how much money a company generates from its day-to-day business activities. Which includes cash inflows and cash outflows generated by a company’s core business activities.
This metric is the first section presented on a cash flow statement and it helps investors understand whether a company can generate enough positive cash flow to pay its operating expenses, fund growth opportunities, reinvest in itself, or return some portion of profits to shareholders.
Investing cash flows and financing cash flows are not included within the operating cash flow section, as they are financial statements that should be reported separately.
Methods to present cash flow from operations
In financial statements, there are two methods used to record statements of cash flow: indirect and direct. Indirect recording refers to documenting revenues and expenses based on when events actually occur. In contrast, direct recording occurs when a transaction takes place.
Indirect
The indirect method is used to calculate net income on a cash basis. The majority of firms report their net income on an accrual basis, which includes various non-cash items and adjustments such as depreciation, amortization, and working capital.
Direct
Under the direct method, finance leaders record the transaction immediately. This method records all transactions on a cash basis and displays the information using actual cash inflow and outflow during the accounting period.
Why does this metric matter?
Financial analysts use operating cash flow to evaluate the financial health and success of a company’s core business activities and make decisions about investing activities or hiring employees, among others.
OCF measures how much cash a company generates from its normal business operations during a period of time and, in general, companies try to increase their OCF since it indicates that they are able to keep up with their operating expenses without needing additional funds from outside investors.
Operating cash flow calculation
We often hear about the importance of understanding how to read a balance sheet, but we don’t always think about what happens once we have done that. There is a lot more to a balance sheet than just showing up balances and liabilities.
The operating cash flow is one of those things. If you want to understand how businesses make money, you will need to learn how to calculate operating cash flow.
Operating Cash Flow help business owners measure how much money their company generates during a specific period of time. This metric is calculated by subtracting expenses from revenue. When calculating operating cash flow, you must account for certain deductions that are typically included in accounting reports. These include depreciation, taxes, and working capital adjustments.
