Gain a better understanding of operating cash flow and make strategic decisions

What is operating cash flow?

Operating cash flow (OCF) is a measure of a company’s financial performance. It is the amount of money generated or used by the main operations of a business in a given period, such as a quarter or a year. It is one of the most important indicators of a company’s overall financial health.

Ronald J Wayne & Associates (RJWA) defines operating cash flow as: “The sum of net income and non-cash expenses, such as depreciation and amortization, added to the adjustment for any change working capital.” The OCF measures the amount of cash that the business has generated from its operating activities, such as sales of goods and services, or from investing activity.

OCF is a comprehensive measure of a company’s financial performance as it provides an indication of how much money the company generates or uses in its operating activities. It is a key indicator of a company’s long-term viability and ability to generate revenue and pay debts.

Creating a positive cash flow is key to running a successful business. Businesses that have a positive cash flow can reinvest profits back into their business and grow. Businesses with negative cash flow are more likely to struggle and may eventually have to shut down.

Examples of Operating Cash Flows

• Revenue from the sale of goods and services
• Net income from operations
• Non-operating investment income
• Cash generated by disposal of assets or inventory
• Payments to suppliers and employees

Tips for improving operating cash flow

• Develop a cash flow projection: Businesses should track their daily cash flow and establish a plan to maximize cash inflows and minimize outflows. This strategy will help businesses anticipate cash needs and take steps to ensure they have enough cash to meet their responsibilities.
• Reduce costs: Businesses can reduce expenses by negotiating better terms with suppliers, negotiating employee salaries, and eliminating unnecessary costs.
• Manage Inventory: Businesses need to monitor inventory levels to ensure there is not too much inventory and vice versa. Inventory optimization will help the business better manage its cash flow.
• Improve receivables: Businesses should ensure timely collection of receivables and devise strategies to minimize day-in-progress (DSO) sales.

Key points to remember

• Operating cash flow is a comprehensive measure of a company’s financial performance.
• It provides an indication of how much money the business generates or uses in its operating activities.
• Creating a positive cash flow is key to running a successful business.
• Traders can use the OCF to make good business decisions.
• The OCF can help traders prioritize investments, manage inventory, calculate payment terms, and more.

What are the components of operating cash flow?

Operating cash flow (OCF) is an important financial measure that shows the total amount of an entity’s cash from operations. It reflects a company’s ability to generate cash from its core business and is a key indicator of its profitability. Understanding OCF is important for forecasting future cash flows and assessing the health of a business. The components of OCF include cash generated from operating activities, investing activities and financing activities.

Cash generated from operating activities

It is the main component of OCF and includes cash generated from sales of goods and services, changes in accounts receivable and inventories, and changes in accounts payable, among other activities. For example, a company that manufactures and sells widgets may generate cash from sales of its widgets, changes in accounts receivable (bills due) and inventory, and any changes in accounts payable (bills outstanding).

Cash generated by investing activities

This component of the OCF includes any cash generated from the sale of investments or assets, plant and equipment. For example, if a company sells a property or factory, it will generate money from the sale.

Cash generated by financing activities

This component of the OCF includes cash generated from the issuance or purchase of debt or equity. Examples include debt issuances, redemption of outstanding debt, and stock dividend payments. By understanding the components of operating cash flow and how they interact, businesses can more accurately assess their financial health, forecast future cash flows, and make informed decisions.

How is operating cash flow different from net income?

Net income and operating cash flow measure two entirely different aspects of a company’s financial condition. Although net income is a measure of profitability, cash flow from operations measures the amount of cash generated by a company from its operating activities.

Net income is determined in accordance with generally accepted accounting principles (GAAP) and begins with revenues and gains, subtracts expenses and losses, and adjusts for all undisclosed accounting items. While operating cash flow is defined as the total amount of money a business earns from its operations and does not consider adjustments for non-cash items.

• Net Income – Measures profitability based on GAAP and includes non-cash items such as depreciation.
• Operating Cash Flow – Measures the actual amount of cash inflows and outflows resulting solely from operations.

While net income and operating cash flow are important to a company’s fiscal health, they reflect different information. Net income helps measure a company’s success in generating profits, while operating cash flow measures the amount of cash available. Operating cash flow is a better gauge of liquidity than net income because a business might be profitable, but still has an insufficient amount of cash to pay its operating expenses.

How can operators use operating cash flow to make decisions?

Operating cash flow (OCF) is used to measure the financial well-being of most businesses. For traders, it can serve as a valuable tool for making good business decisions. The OCF tracks the cash generated from core business operations, and for this reason, operators can use the OCF to analyze the effects of business decisions on their finances and make subsequent strategic decisions.

Here are some examples of how operators can use OCF to make decisions:

• Calculation of payment terms: Operators can use the OCF to calculate the amount of payments they can afford to receive from their customers. This helps them balance the costs of goods and services with the credit terms they offer their customers.
• Prioritize business investments: OCF helps operators analyze the financial impacts of various investments such as new equipment, IT infrastructure, etc., and helps to better understand their financial situation.
• Inventory Management: OCF helps operators review their inventory management decisions and make changes as needed to increase efficiency and improve cash flow.

In addition to the examples above, the OCF can also help operators determine their financial risks, set performance targets, approve loans, and more. It is important to note that traders should assess the accuracy of their OCF calculations and ensure the data is up to date before making decisions.

What methods are used to reduce operational expenses?

Reducing operational expenses is a primary goal for most businesses, as high overhead costs can quickly hurt profits. Fortunately, there are a few methods you can use to cut costs and keep your overhead down. Here are some of the most effective strategies for reducing operational expenses:

• Reduce utility bills – One of the easiest ways to reduce operational expenses is to reduce your utility bills. Look for ways to turn off lights and other energy-consuming devices during off-hours, take advantage of insulation and automated thermostat systems, and reduce air conditioning use.
• Buy used equipment and supplies – Buying used equipment and supplies is a great way to cut costs, especially if you’re working on a budget. When buying used items you should always consider their quality and perceived value to ensure you are getting the best possible deal.
• Negotiate with sellers – Don’t be afraid to negotiate better terms with sellers. When possible, ask for lower rates or bulk discounts that can help you save money. Also, most providers are happy to offer some sort of credit terms if you ask.
• Track your finances closely – One of the most important things you should do when trying to cut operational expenses is to keep track of your finances closely. Regular spending monitoring can help you quickly identify areas where you might be overspending and then take corrective action.

Implementing these strategies can help you reduce operational expenses and improve the overall profitability of your business. Remember, it’s important to constantly monitor your spending and budget closely, identify areas where you may be overspending, and then take steps to reduce costs.

How are operating cash flows related to liquidity ratios?

Operating cash flow is an important component of liquidity ratios because it helps gauge an organization’s ability to repay short-term liabilities. Liquidity ratios measure a company’s ability to cover its current liabilities with current assets. Operating cash flow is an important part of current assets because it measures the cash that a business has generated in its operating activities over a period of time.

Cash flow from operating activities is mainly used to calculate several liquidity ratios, such as current ratio, quick ratio and cash ratio. For example, the current ratio is calculated by dividing the total current assets by the total current liabilities. A higher current ratio indicates that the company can easily meet its short-term obligations. Operating cash flow is an important component of current assets and therefore higher operating cash flow could result in a higher current ratio.

Similarly, the quick ratio, also known as the acid-test ratio, is calculated by subtracting inventory from current assets and then dividing by current liabilities. Since inventory is generally considered less liquid, it is not included in the denominator when calculating quick reports. Operating cash flow is an important component of current assets and therefore higher operating cash flow could result in a higher quick ratio.

Finally, the cash ratio is calculated by dividing cash and cash equivalents by current liabilities. This is the most conservative liquidity ratio, as it only takes into account highly liquid assets such as cash and cash equivalents. Cash flow from operations is not included in the cash ratio calculation because it includes non-cash items such as depreciation and amortization. In other words, even though operating cash flow is an important component of liquidity ratios, it is not included in the cash ratio calculation.

In summary, operating cash flow is an important component of liquidity ratios because it helps assess an organization’s ability to repay its short-term liabilities. Examples of liquidity ratios that include operating cash flow are current ratio and quick ratio. Cash flow from operations is not included in the cash ratio calculation, which only considers cash and cash equivalents.

How to improve operating cash flow?

Operating cash flow, which is money flowing in and out of your business from core operations, is an important metric used to measure financial health and performance. Many strategies can be used to improve cash flow and help ensure that the business meets its financial goals.

Here are some examples and tips to help improve operating cash flow:

• Monitor Accounts Receivable: Keeping a close eye on Accounts Receivable can help you quickly identify any past due bills and take action to get them paid.
• Organize finances: Having clear record keeping of your business finances can help you identify cut costs, which will leave more funds available for the business.
• Negotiate Supplier Agreements: Consolidating your supplier agreements and maintaining a strategic relationship can help you access better deals, discounts, and payment terms.
• Incentivize payments: Encouraging customers to pay their bills faster, perhaps by offering a small discount for prompt payment, can help manage cash flow better.
• Focus on Marketing: Spending more effort on marketing initiatives can bring frontline growth, which should generate more cash flow for the business.
• Prioritize Collections: Moving collection initiatives to the front of the financial cycle can reduce delinquencies that can slow cash flow.

Implementing these strategic changes and leveraging them regularly can help ensure that your business maintains healthy cash flow. This, in turn, can help ensure that business goals are met and the business has the resources to thrive.

Conclusion

Operating cash flow (OCF) is an important measure of a company’s financial well-being. It gives insight into how much money the company generates or uses in its operations. Businesses need to properly manage their OCF to ensure positive cash flow and remain profitable. By understanding the components of OCF and how they interact, businesses can better assess their financial health, forecast future cash flows, and make informed decisions.