Operating Cash Flow

Operating cash flow (OCF) is the cash generated by a company’s core business operations. It excludes investing and financing cash flows and shows whether operations are self‑funding.

Indirect Method

OCF = net income + non‑cash items (depreciation, amortization, stock‑based comp) ± changes in working capital (ΔAR, ΔInventory, ΔAP, etc.).

Example

Net income 80k; depreciation 15k; ΔAR +10k (use of cash); ΔInventory −5k (source of cash); ΔAP +5k (source of cash).

OCF = 80 + 15 − 10 + 5 + 5 = 95k.

Why It Matters

• Indicates the health of core operations and ability to fund growth without external financing.
• Key input for discounted cash flow (DCF) and free cash flow calculations.
• Highlights quality of earnings: high net income with weak OCF can be a red flag.

Step‑by‑Step (Indirect Method)

1. Start with net income.
2. Add back non‑cash expenses (depreciation, amortization, stock‑based comp).
3. Adjust for working capital changes: subtract increases in AR and inventory; add increases in AP and accrued liabilities.
4. Include other non‑cash adjustments (deferred taxes, impairment) as appropriate.

Pitfalls

• Misclassifying financing/investing cash flows as operating (e.g., interest received may be investing under IFRS).
• Ignoring seasonality in working capital that temporarily inflates/deflates OCF.
• Relying on net income alone without reconciling to cash—accrual accounting can obscure cash reality.

FAQs

Direct method?
Reports cash received from customers and cash paid to suppliers/employees directly, without accrual adjustments.

Working capital?
Changes in AR/AP/Inventory represent timing differences between revenue/expense recognition and cash movements.