Operating cash flow, or OCF, calculates how much cash an organization earns through normal business operations. The goal is to determine if the company is generating enough positive cash flow to continue its current path or expand in the future.
Businesses without enough operating cash flow might seek financing to assist with growth. They might also have to change their operating procedures or business plans to improve their overall performance and financial health.
Using an operating cash flow formula to calculate a company’s cash flow gives a more thorough overview of organizational health than using net income because it includes other variables in the equation. This guide provides information on how to calculate operating cash flow and why it’s an essential formula for business owners to understand.
Operating Cash Flow Formula Options
You can calculate operating cash flow using a few different formulas. The goal is to better understand the company’s cash inflows and outflows relating to regular business activities. These formula options include:
The Simplest Formula
The most straightforward operating cash flow formula takes the total cash the business receives for sales and subtracts the amount the company pays for operating expenses. These operating expenses can include things like employee salaries, money paid to vendors and suppliers, income tax paid, and interest paid on loans. Using this simple formula provides a broad overview of the organization’s cash flow, but more information is often necessary.
The Long Form Method
Another method of calculating cash flow involves taking the number you arrive at using the simplest formula and adding depreciation to it. You’ll then subtract changes in working capital, which you’ll arrive at by calculating your current assets and subtracting your liabilities. This method provides more information because it incorporates accounts payable and accounts receivable into the analysis, so not everything is dependent on cash received.
It’s vital to understand accelerated depreciation when making these calculations because it will influence your cash flow outcomes. The gist is that accelerated depreciation allows for a more significant devaluation of an asset in its first few years before slowing as the asset ages. Using this accounting method could decrease your operating cash flow this year but increase it on paper in the years to come.
The operating cash flow formula you use will depend on its purpose and your business. Some companies can get by with the simple formula, but larger organizations with numerous assets and income variables will have to dig a little deeper into the numbers.
Six Reasons to Pay Attention to Operating Cash Flow
Businesses of all sizes must consider their operating cash flow because of the information it provides on the company’s financial health. Entrepreneurs who aren’t paying attention to these numbers should start as soon as possible. Reasons to make these calculations include the following:
1. Provides a Clear Overview of Business Operations
The idea behind an operating cash flow formula is that it allows you to see cash inflows and outflows related to your main business activities. These activities might include buying and selling merchandise, paying salaries, and providing services. Companies not making money through these activities might want to switch things up moving forward.
2. Eliminates Accounting Anomalies
Following an operating cash flow formula helps eliminate how much accounting anomalies influence the company’s bottom line. Having a sale on your merchandise, for example, could lead to an influx of cash, but that doesn’t necessarily mean the business is doing well because it depends on how much you paid for those items in the first place.
3. Assists With Business Planning
Operating cash flow allows you to see if the company is becoming more or less profitable, so you can make adjustments based on your findings. It’s vital you understand your company’s ability to turn a profit on its own without factoring in investments or other methods of making money. Businesses with negative operating cash flow could require a change of direction before becoming profitable.
4. Shows Where You’re Spending Money
Using an OCF formula helps you understand where you’re spending money. Looking at your expenses shows you where most of your operating expenses are going so you can potentially reduce those costs in the future. Areas you might consider spending less include salaries, merchandise, and marketing.
5.Strengthens Your Business Relationships
The last thing you want is to place an order with a supplier only to realize you don’t have the cash to pay for it. This scenario would damage your business relationship and could make it more challenging to succeed in the future. Tracking your operating cash flow makes it easier to set payment schedules so you don’t end up facing too many invoices at once without having enough cash on hand.
6. Helps With Growth
Your OCF calculations can help you know if you’re ready to expand. Businesses with plenty of cash flow might have the opportunity to grow into new markets or increase their presence in their existing locations. It’s also easier to attract investors if your operating cash flow doesn’t show any concerns.
There’s a significant amount of information to understand as a business owner, and digging into the data as much as possible gives you a clearer picture of your company’s soundness. OCF is an indicator of how much money the organization is really making, so it’s worth keeping an eye on in the future.
Speak to the Pros to Optimize Your Cash Flow
Managing a business has a lot of moving parts, and it’s normal to seek out help with the financial aspects. Bogart Wealth can help you find the right operating cash flow formula for your business’s unique needs and help set you up for future success. Our expert team can crunch the numbers and advise you on the best path for you and your business. Contact Bogart Wealth to speak with an expert about our wealth management solutions.