Operating Cash Flow: What is it and How to Calculate it

Getting a grasp of your business’ financial health can be hard, it’s not always obvious when your business is succeeding or failing.

That’s where important metrics like operating cash flow (OCF) come in. They tell you how your business is doing, specifically, how much cash is generated from its core operations.

For Singaporean SMEs, understanding OCF is a top priority. Of course, it helps you gauge whether your business can cover daily expenses, like salaries, rent, and inventory, without relying on outside funding. It also gives you a clearer picture of sustainability and growth potential.

So, let’s break down what OCF really means and how exactly you can calculate OCF accurately.

Understanding operating cash flow

Operating cash flow is the amount of cash a business generates from its normal operating activities. That usually includes:

• Cash received from sales
• Payments made for expenses like:
• Supplies
• Wages
• Utilities

That may sound simple, but businesses often make mistakes here. Some, for instance, mix up cash flow from operations and net income. Net income reflects the profit after all expenses, including taxes and interest, are deducted from revenue. It also includes several non-cash items like depreciation or unrealised gains and losses. OCF, on the other hand, focuses strictly on actual cash movement.

For example,if a company records revenue but hasn’t received payment, that amount appears in net income but not in OCF

That’s no trivial distinction. OCF provides a more accurate snapshot of available cash, meaning better decision-making in the here and now. 

Importance of operating cash flow for Singaporean SMEs

For SMEs in Singapore, where efficient cash management can make or break a business, OCF shouldn’t be underestimated.

Here’s where it really makes the difference:

• Budgeting and planning: OCF helps business owners assess whether their operations are generating enough cash to support everyday expenses, without depending on costly loans or additional capital. That means powerful insight that’s essential for not only setting realistic budgets, but planning financial steps.
• Financial reporting: Profit figures alone don’t cut it. OCF paints a much clearer picture of a company’s liquidity and operational strength. Under the Singapore Financial Reporting Standards (SFRS), businesses are encouraged to present cash flow statements as part of their financial disclosures. So, accurate OCF reports are crucial for compliance.
• Credibility: The truth is, investors and lenders often prioritise OCF over net income when evaluating a company’s performance. A strong OCF suggests self-sustainability (free of debt), and indicates whether a company has expansion potential, which makes it an attractive investment opportunity. You might not be seeking investment right now, but when the time comes, OCF reporting might just be your trick up the sleeve.

Methods to calculate operating cash flow

It’s important you know there’s no single formula for calculating OCF. You can use two calculation methods, either direct or indirect. 

Both aim to determine how much cash is generated from a company’s core operations. However, they differ in how the information is presented and the data required. Knowing both formulas helps keep things accurate.

Direct method

Your first step will probably be the direct method. This cash flow from operations formula calculates OCF by listing actual cash inflows and outflows related to operating activities. It gives you a clear view of how cash moves in and out of the business.

Here’s the formula:

Operating Cash Flow = Cash Received from Customers – Cash Paid to Suppliers and Employees – Operating Expenses – Taxes Paid

Pretty much exactly what you’d expect, and you’ve probably noticed the advantages of this method already:

• Offers transparency and a direct view of cash activity
• Makes it easier for business owners to see where their money is going

However, it can be more challenging to implement, as it requires detailed cash transaction records.

Indirect method

The indirect method is another way to go about calculating OCF. Here, we start with net income and adjust for non-cash items and changes in working capital, like receivables, payables, and inventory.

This indirect OCF foruma is:

Operating Cash Flow = Net Income + Non-Cash Expenses +/- Changes in Working Capital

SMEs that use accrual accounting find the indirect method particularly useful, because it aligns with standard financial statements. 

It may be less intuitive than the direct method, but it’s easier to prepare since it draws from data already captured in the income statement and balance sheet.

Step-by-step guide to calculating OCF

The direct method for calculating OCF is relatively straightforward. All you need are the relevant profits and expenses from your balance sheet.

However, if you use accrual accounting, you’ll find the indirect method better. This method adjusts net income to reflect the actual cash generated by operating activities, taking into account non-cash items and changes in working capital.

Here’s how to do it:

1. Start with net income: First find your net profit on your income statement. This is your overall net income and includes all revenues and expenses.
2. Add back non-cash expenses: Now, you have to include non-cash expenses that still affect profit. These are accounting charges, not real cash outflows, but here, they count. Include:
3. Depreciation
4. Amortisation
5. Adjust for changes in working capital: Changes in current assets and liabilities affect your cash flow. Consider, for example:
6. Accounts Receivable: If receivables increase, it means more cash is tied up and hasn’t been collected. Simply subtract the increase.
7. Inventory: An increase means cash was used to buy more stock. Again, subtract the increase.
8. Accounts Payable: An increase means you’re holding onto your cash longer. Here, you have to add the increase.

Let’s clear things up with an example:

Let’s say your SME’s financials for the year look like this:

• Net Income: SGD 50,000
• Depreciation: SGD 10,000
• Increase in Accounts Receivable: SGD 5,000
• Increase in Inventory: SGD 8,000
• Increase in Accounts Payable: SGD 6,000

The OCF formula would look like this:

= 50,000

+ 10,000

– 5,000

– 8,000

+ 6,000

= SGD 53,000

Your OCF is SGD 53,000. This means your core business operations generated SGD 53,000 in actual cash during the year.

Common challenges and how to overcome them

While juggling multiple financial figures and different ways to calculate OCF, it’s normal for Singaporean SMEs to hit the odd brick wall. However, these mistakes, even minor ones, can lead to serious consequences for your business planning.

Being aware of these common challenges and knowing how to overcome them can help ensure your cash flow statements truly reflect your business' financial state.

Inaccurate record-keeping

The first mistake occurs when the figures needed to figure out your OCF aren’t accurate. Without accurate data, key figures like net income, working capital changes, or non-cash expenses can be misstated.

The solution: The best way to keep your records clean and tidy is with cloud-based accounting software like QuickBooks, which helps you maintain organised financial records and generate reports in seconds.

Misclassification of cash flows

Another easy mistake to make, in the actual calculation phase, is misclassifying cash flows. For example, recording a loan repayment under operating activities instead of financing activities could throw off your final OCF figure.

The solution: Take the time to get to grips with SFRS. These clearly distinguish between operating, investing, and financing cash flows. 

Overlooking non-cash adjustments

As seen with the indirect method for calculating OCF, non-cash items matter. Depreciation, amortisation, and provision adjustments all factor into an accurate OCF, so overlooking them can cause issues.

The solution: Make sure you review every income statement and add back all relevant non-cash charges during the OCF calculation. We’d even advise using a checklist to ensure no adjustments are missed during each reporting cycle.

Leveraging QuickBooks for efficient cash flow management

It should be clear by now just how crucial accurate OCF figures are. Not just for compliance, but for your own operational needs, too. 

If you want to completely eliminate financial record-keeping hassle and plan for growth the smart way, try QuickBooks. 

QuickBooks has mastered automation, giving you more time to focus on your core business activities and plans for the future.

Here are the key ways in which QuickBooks supports OCF management in Singapore:

1. Automated cash flow statements: There are a lot of moving parts when it comes to cash flow calculations, leaving room for error. QuickBooks automatically generates cash flow statements using real-time transaction data. By linking your business bank accounts and credit cards, it pulls in all relevant financial activity and generates accurate reports. 
2. Real-time financial reporting: The ability to make smart business decisions quickly is what sets successful modern SMEs apart. QuickBooks provides up-to-date dashboards that show:
3. How much cash your business has
4. Where it’s going
5. What’s coming in
6. Compliance with Singapore accounting standards: Getting your figures wrong can land you in trouble with IRAS and other government bodies. However, staying on top of rapidly evolving regulations can be a challenge. QuickBooks is built to align with local accounting requirements, including the SFRS, meaning your reports are always formatted correctly and are compliant.

On top of those features, we’ve made OCF calculations as quick and easy as possible:

1. Go to Reports > Cash Flow Statement
2. Select your date range
3. Review the automatically calculated figures for operating, investing, and financing activities
4. Use the Customise function to filter or focus specifically on operating cash flow
5. Export or share your report as needed

Need some help handling QuickBooks? Our handy Learn & Support section is always there to show you the ropes.

The best part is, you can see for yourself just how much difference QuickBooks can make to your OCF process with a free 30 day trial.

Conclusion

The truth is, operating cash flow is more than how much cash you have. It’s a fundamental metric, one that Singaporean SMEs use every day to maintain financial health and support sustainable growth. 

However, many SMEs unfortunately lack the time and resources to calculate OCF properly. Mistakes can arise, which can result in missed opportunities. 

The best way to sidestep this? Use cloud-based solutions like QuickBooks. Try it for free today!