Operating Cash Flow: Definition, Meaning and Limits
Operating cash flow is the money a business generates from day-to-day operations — before investing and financing. What it says, how it differs from EBITDA and profit, and what sits behind a negative figure.
Marcus Smolarek
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In short: Operating cash flow is the money a business generates from its day-to-day operations — before investing and before financing. It is the one of the three cash flow types where a negative figure is a warning sign in its own right. This page explains what it says, how it differs from EBITDA and profit, and what can sit behind a negative number.
What operating cash flow is
Operating cash flow is the difference between the cash received and the cash paid out in the ordinary course of business — the money a company earns under its own steam, before it invests or raises finance.
In financial statements it appears as cash flow from operating activities; that is the wording used by IAS 7, the international standard for the statement of cash flows. It is commonly abbreviated OCF.
It is the first of the three sections of a cash flow statement. The other two — investing and financing activities — describe what happened to the money afterwards. Only this first one says whether the business pays for itself.
How it is calculated
There are two routes, and they end at the same figure:
| Direct method | Indirect method | |
|---|---|---|
| Starting point | the payments themselves | net income from the income statement |
| Calculation | operating cash received − operating cash paid | net income ± non-cash items ± change in working capital |
| Needs | categorised bank transactions | income statement plus two balance sheet dates |
| Advantage | available monthly, no closing required | the data is in the annual accounts anyway |
| Drawback | depends on clean categorisation | only possible once the accounts are closed |
A correction to something that circulates strikingly widely on this topic. Cash received from customers and collected receivables are cash items. They belong in the direct method as inflows, not in the indirect method as "non-cash revenues". And what gets added back in the indirect method are provisions, not reserves: reserves are equity, and setting them aside is not an expense.
| Non-cash expenses (add) | Non-cash revenues (deduct) |
|---|---|
| Depreciation and amortisation | Write-ups |
| Additions to long-term provisions | Release of provisions |
| Decrease in finished and unfinished goods inventory | Increase in finished and unfinished goods inventory |
The full line-by-line scheme, with an example that works through both methods, is in How to calculate cash flow.
Operating cash flow, EBITDA and profit
These three are constantly treated as interchangeable, and the differences are exactly what makes operating cash flow useful:
| What it measures | Includes working capital? | Defined in | |
|---|---|---|---|
| Net income | revenue minus expenses | no | accounting standards |
| EBITDA | earnings before interest, tax, depreciation and amortisation | no | no standard at all |
| Operating cash flow | cash in minus cash out from operations | yes | IAS 7 |
The third column is the one that matters. EBITDA strips depreciation out of profit and therefore looks like something close to a cash figure — but it ignores whether customers have paid and whether the warehouse has grown. That is precisely where the gap between a good number and money in the bank opens up.
A company growing revenue by 40 % can post rising EBITDA and falling operating cash flow at the same time. Both are correct, and only one of them pays wages.
There is also this: EBITDA is not defined in any accounting standard. Anyone may calculate it as they see fit. Operating cash flow follows a set scheme. More on the distinction in Cash flow, profit, EBIT and EBITDA.
Operating, free and total cash flow
| Figure | Formula | Answers |
|---|---|---|
| Operating cash flow | operating cash in − operating cash out | Does the business pay for itself? |
| Free cash flow | operating cash flow − investment in fixed assets | What is left for debt repayment, distributions, reserves? |
| Total cash flow | operating + investing + financing cash flow | How did the bank balance change overall? |
Free cash flow is the figure investors look at. Operating cash flow is the one to watch yourself: it cannot be flattered by postponing investment.
What a negative operating cash flow means
A negative operating cash flow means the day-to-day business consumed more cash than it brought in. Unlike the other two cash flow types, that is never neutral information.
There are three causes, and they differ in urgency:
- Losses. The business simply does not earn enough. Recognisable because net income is negative too. This is the serious case.
- Growth. Revenue — and with it receivables and inventory — grows faster than cash comes in. Recognisable by positive profit alongside negative cash flow and a sharply increased working capital. Not an alarm, but a financing requirement that needs planning.
- Payment behaviour. Customers pay later than agreed while nothing about the business has changed. Recognisable by a higher receivables balance at unchanged revenue. This is the one that can be fixed fastest.
Telling the three apart is the actual work. A single negative figure says nothing; the combination of profit, working capital and receivables says everything.
A worked example
The figures are an invented example.
A company reports €120,000 net income. Add €45,000 depreciation and €10,000 of additions to long-term provisions; deduct €30,000 of increased receivables and €15,000 of increased inventory; add €20,000 of increased trade payables.
- Operating cash flow = 120,000 + 45,000 + 10,000 − 30,000 − 15,000 + 20,000 = €150,000
On €980,000 of revenue that is a cash flow margin of around 15 %. What it means in practice: the business generates €150,000 a year under its own steam — enough to fund €70,000 of investment and €40,000 of debt repayment without any new money coming in.
What it cannot tell you
Operating cash flow is a backward view. It says what happened in a closed period, and the more it rests on the annual accounts, the later it says it.
For the question that actually comes up day to day — will there be enough money next quarter — no better ratio helps. It takes a different direction: a liquidity plan that carries cash in and cash out forward with dates attached. The operating cash flow of the last eight quarters is, however, the most reliable basis for the assumptions that plan runs on.
Frequently asked questions
What is operating cash flow?
Operating cash flow is the cash a company generates from its ordinary business activities — cash received minus cash paid, before investing and financing. In financial statements it appears as cash flow from operating activities and is abbreviated OCF.
How do you calculate operating cash flow?
Indirect method: net income plus non-cash expenses minus non-cash revenues, adjusted for the change in receivables, inventory and trade payables. Direct method: operating cash received minus operating cash paid. Both routes give the same result.
What is the difference between operating cash flow and EBITDA?
EBITDA is an earnings figure and does not account for whether customers have paid or how much cash is tied up in inventory. Operating cash flow does, through the change in working capital. A growing business can show rising EBITDA and falling operating cash flow at once. EBITDA is also not defined in any accounting standard, while operating cash flow is.
What does a negative operating cash flow mean?
That the day-to-day business consumed more cash than it produced. Three causes are possible: a loss, cash tied up by growth, or a deterioration in how customers pay. Which one applies shows in the comparison with net income, working capital and the receivables balance.
What are non-cash expenses?
Expenses that reduce profit without cash leaving the business — chiefly depreciation, additions to long-term provisions, and decreases in inventory. In the indirect method they are added back to net income. Reserves do not belong here: they are equity, and setting them aside is not an expense.
What is the difference between operating and free cash flow?
Free cash flow is operating cash flow less investment in fixed assets. It says what remains, after the investment the business needs, for debt repayment, distributions or reserves.