Operating cash flow represents the amount of cash generated by the main activities of your business. This metric gives you an idea of how well your business runs and indicates whether you can turn a profit from your company’s activities.
Factors That Go Into Calculating the Operating Cash Flow
For example, if you own a retail business or e-commerce shop, your operating cash flow comes from the sale of goods to individual customers. This type of business may generate cash from other activities, such as renting store space to other shops, teaching classes on how to run a retail business, or generating ad revenue from a blog-based website. However, the cash you generate from these minor activities doesn’t count toward your operating cash flow.
Using the Operating Cash Flow Formula
Calculate your operating cash flow using the direct method or the indirect method. For example, you have a total revenue of $200,000 and operating expenses, such as the cost of labour and equipment maintenance, of $150,000. Your operating cash flow comes from the difference.
To calculate operating cash flow with the direct method, use this equation:
- Total revenue – total operating expense = operating cash flow, or:
- $200,000 – $150,000 = $50,000
To calculate the operating cash flow of your business using the indirect method, adjust the net income of your business by removing any revenue that doesn’t affect your cash, such as changes in accounts payable and accounts receivable.
For example, say the net income of your business is $150,000. Changes in your accounts payable total $25,000, and changes in accounts receivable total $60,000, both of which are non-cash expenses. Accounts receivable is an asset because it reports on cash that hasn’t changed hands yet. You subtract out accounts payable because you still have that cash on hand, and you list it as an increase in working capital.
The operating cash flow for the indirect method looks like this:
- Net income + non-cash expenses – increase in working capital = operating cash flow; or:
- $150,000 + $25,000 – $60,000 = $115,000
Maintaining Healthy Cash Flows
Once you know your operating cash flow, you can use it as a metric to judge your operations and forecast future cash flows. This is especially helpful if you’re operating a goods-based business, where physical assets, such as buildings and equipment, are an important part of your net income but may distort the amount of cash that is actually flowing through your business.
Maintaining a healthy cash flow gives you more options when you’re making business decisions. A healthy cash flow is especially attractive to potential investors – it shows that you can quickly adapt to future changes, ensuring a brighter long-term outlook and less vulnerability to risk.
Shielding Your Company from Market Forces
Maintaining positive cash flow can be critical to managing demand downturns and other external market factors. These factors affect not only small businesses like yours but large corporations as well. More than 64% of Canadian business owners report issues with cash flow. This struggle with cash flow leads to:
- Lost opportunities
- Sleepless nights
- Failure to pay employees on time
The reported reasons for this decline in cash flow are slowing payments from customers and credit card companies. Both are external market factors that you can’t control, but it’s a good idea to shield yourself from these issues. Creating a nest egg when times are good can help you weather the slower times that are out of your control.
Another possible way to shield your small business is to encourage customer to pay more quickly. One way to do this is faster invoicing and offering a variety of payment options. This can help your company get paid more quickly and keep your cash flow positive even during economic downturns.
Any business is subject to outside market forces, and when winds change, companies with strong cash flows can stand out as the big fish in a shrinking pond. Isn’t that the position you want to find yourself in? By learning how to identify and calculate your operating flow – and using that knowledge to measure your performance, invest wisely, and brace your company for the future – you can set yourself apart in your field.
What an Operating Cash Flow Means for Your Business
Your operating cash flow gives you an idea of how much cash you have on hand at any given moment. You can plan for future expenditures, create a budget, hire more employees, or give more money back to your investors with that extra cash. Tracking income and expenses in QuickBooks comes in handy when generating custom reports that show your operating cash flow. 5.6 million customers use QuickBooks. Join them today to help your business thrive for free.