No matter how long it has been in business, big or small, any company needs good accounting to stay afloat. Otherwise, they can start going bankrupt without even realizing it.
One of the most important and basic aspects of accounting for any business to manage is operating cash flow. However, for those who are not good at accounting, it cannot be very clear.
Terms to consider before calculating operating cash flow
First, it is necessary to know several important values to calculate the operating cash flow and obtain an accurate result to determine whether a company is profitable.
Operating cash flow (OCF)
Operating cash flow is a specific amount of money the company generates over a certain period. For this, its normal and common operations are considered.
Net income
Net income considers all activities the company performs, whether they are typical operations. In the net income, the money obtained from sales, investments, and other commercialization are included, and total expenses are subtracted.
Depreciation
Depreciation is an accounting term used when a movable or immovable asset loses value with time, or use, or becomes obsolete. It is an estimate and an expense that does not come directly from the company’s money.
Although it does not come out of the company’s money, it must be considered in the accounting because it is still an asset of the company, and at some point, it must be changed or replaced, and this expense does come directly out of the company’s money.
Working capital
Working capital is all the money the company has available to meet its economic needs relatively short term. It considers the need for the environment, payroll, suppliers, etc.
Non-cash expenses
Non-cash expenses are the sum of various expenses that cannot be recorded numerically, one of the most common of which is the depreciation above. In other words, these expenses are not incurred with cash.
Although the company has not directly paid this expense with cash, it must be considered to determine the profitability of a company.
How is the Operating Cash Flow Effect calculated?
There is more than one formula that can use to calculate operating cash flow, depending on the company’s calculation priorities or the preferences of the accountant or bookkeeper.
Simple formula
The simple formula is the shortest way to calculate operating cash flow. It can be stated in several ways:
- Operating cash flow = Total cash from sales – Cash spent on operations
- Operating cash flow = net income + depreciation – increase in working capital
- Operating cash flow = net income – increase in working capital + non-cash expenses
Long formula
This formula is quite a bit more complex, and while it may not be the preferred formula, it is the most ideal when you do not have the numbers ready for the above formula.
Operating cash flow= (net income+ depreciation+ stock-based compensation+ deferred taxes+ other non-cash expenses+ increase in accounts payable+ increase in accrued expenses+ increase in deferred expenses) – (increase in accounts receivable+ increase in inventory).
Why is it important to calculate operating cash flow?
The idea of calculating operating cash flow is to reveal the true ability of the company to earn profits based on its normal operations and not on extra transactions that can make profits.
Extra transactions can be very profitable. However, they are not stable, and a company is dependent on these types of transactions to stay afloat; when they stop happening or stop working, the company declines in a very short time.
Calculating operating cash flow demonstrates how well the company can stay in a good financial state with its typical operations alone without needing other unstable income.
When an operating cash flow is negative, you are looking at a company where if you do not act soon and do not receive more income, it could start to decline and even go bankrupt.
When this formula is consistently performed, the company is constantly monitored to determine whether it is still profitable and how profitable it is.
On the other hand, if the company has a long time with an operating cash flow and nobody has noticed it, it may face an economic collapse and even close to bankruptcy. It is best to perform this formula constantly to avoid the situation.
In other words, this calculation determines whether a company can stand on its own or whether it needs more income to keep running.