Operating Cash Flow (OCF)
What is OCF?
Operating cash flow (OCF) is the cash a company generates from its core business operations—producing and selling goods or services—over a reporting period. It excludes cash flows from investing (e.g., buying equipment) and financing (e.g., issuing debt or equity). OCF shows whether a company can fund day-to-day operations from its own activities.
Simple representation:
OCF = Net income + Non-cash expenses − Increase in working capital
Why OCF matters
- Measures operational health: Shows how well a company converts sales into cash.
- Indicates liquidity: Helps assess short-term ability to pay bills and obligations.
- Signals investment potential: Strong OCF supports reinvestment, dividends, or debt reduction.
- Assesses solvency: Companies with sustained positive OCF are better positioned to service debt.
- Tax and analysis relevance: OCF components affect taxable income and financial analysis.
The operating cash flow ratio (OCF ÷ current liabilities) gauges whether cash from operations can cover short-term liabilities; a ratio > 1.0 is generally favorable.
Components of OCF
Cash inflows
Cash received from customers (cash sales and collections of receivables)
Other operating receipts and reimbursements
Cash outflows
Payments for inventory and raw materials
Employee wages and benefits
Operating expenses (rent, utilities, insurance)
Taxes and other operating payments
Working capital effects
Decrease in accounts receivable → increases OCF (customers paying faster)
Increase in inventory → decreases OCF (cash tied up in stock)
Increase in accounts payable → increases OCF (delaying supplier payments)
Decrease in accrued expenses → decreases OCF (paying obligations sooner)
How OCF is calculated
There are two accepted methods; both should arrive at the same OCF.
Indirect method (most common)
Start with net income and adjust for non-cash items and changes in working capital.
Typical adjustments:
Add back non-cash expenses (depreciation, amortization)
Subtract increases in working capital (e.g., accounts receivable, inventory)
Add increases in liabilities related to operations (e.g., accounts payable)
Remove non-operating gains/losses
Basic formula:
OCF = Net income + Depreciation & Amortization − Change in net working capital
Example:
Net income $100M + Depreciation $150M − AR increase $50M − AP decrease $50M = OCF $150M
Direct method
Lists actual cash receipts and payments during the period.
Typical line items:
Cash received from customers
Cash paid to suppliers and employees
* Cash paid for interest and taxes
Basic formula:
OCF = Cash received from customers − Cash paid for operating expenses
Example:
Cash receipts $80M − Cash payments to suppliers $25M − Wages $10M = OCF $45M
Worked example (small retail business)
Given:
Net income: $50,000
Depreciation: $10,000
Increase in accounts receivable: $5,000
Increase in inventory: $3,000
* Increase in accounts payable: $8,000
Indirect-method calculation:
OCF = $50,000 + $10,000 − $5,000 − $3,000 + $8,000 = $60,000
Practical considerations
- A positive OCF indicates the business generates cash from operations; negative OCF may signal cash-strain even if accounting profits exist.
- OCF can fluctuate due to seasonality, working capital timing, or one-off items—look at trends, not a single period.
- Analysts often prefer OCF over net income for assessing sustainable cash generation, because net income includes non-cash and accrual-based items.
Bottom line
Operating cash flow isolates the cash generated by a company's core activities and is a key indicator of liquidity, operational efficiency, and the ability to fund growth or meet obligations without external financing. Evaluate OCF alongside other financial metrics and across multiple periods for a reliable view of operational cash performance.