Investing Basics

Articles of the Week

Operating Cash Flow - Cash Flow from Operations - Finance Glossary

Cash Flow from Operations (Operating Cash Flow) compares the difference between reported Operating or Net Income and actual cash flows of the company. If a company does not have sufficient cash resources set aside to pay off its Current Liabilities, then this shows a sign of inefficiency or problems with inventory turnover (goods not getting sold). A healthy company is one where inventory is turned over at industry standard rate and one where there's enough cash in the bank to meet both short term and long term debt obligations. Operating Cash Flow therefore checks the quality of a company's reported earnings.

Operating Cash Flow is also known as "Cash Flow Provided by Operations" or "Cash Flow from Operating Activities."

The formula for Operating Cash Flow is:

 (Earnings Before Interest & Taxes + Depreciation) - Income Taxes

Characteristics of Operating Cash Flow

  • If a firm reports high earnings (net income) but negative Operating Cash Flows, there could potentially be fraud involved in the calculation of the net income figures (use of aggressive accounting procedures).
  • If the Cash Flow from Operations Ratio is less than 1, or steadily declining over a longer period of time, this can show signs of operation inefficiencies and cash flow problems.

Analysis of Operating Cash Flow

Investors like to focus a lot on figures such as Earnings Per Share or reported Net Income for the current Quarter. While these figures are important, cash is also very important! No cash, no business!

Operating Cash Flow can tell investors of companies that are churning out more cash faster than they are bringing in cash. How do you find the Operating Cash Flow number? You can look it up in the Statement of Cash Flows in the Balance Sheet section of a firm's statements. A positive Operating Cash Flow number shows a healthy company, while a negative # shows signs of cash flow problems.

Free Cash Flow

Related to Operating Cash Flow is the Free Cash Flow ratio. It is calculated as:

 Operating Cash Flow - Capital Expenditures - Acquisitions

Capital Expenditures are those expenses necessary to remain competitive in the market, such as buying new technology to replace outdated technology, acquiring capital investments that have a positive Net Present Value, etc.

A firm with a positive Free Cash Flow number is healthy for investors because after paying off all current expenses (such as salaries, wages, short-term debts), the company has enough cash flow to make capital expenditures to grow into the future.