Operating cash flow (OCF): Definition, Ratio and Formula

Operating cash flow is the amount of cash that your business generates through its regular operating activities within a certain timeframe. The ratio of how much money you’re making to how much you need to spend helps determine whether a business has enough cash to cover expenses and plan for future growth.

There are two common ways that businesses can calculate operating cash flow. The first one is the direct method, which is used for cash-based accounting. To calculate the direct method, you take revenue and minus operating expenses. This does not include income from capital gains (investments) but shows how well your business is performing from primary activities.

So, if your balance is negative, this means that you have more money coming out of your business than coming in - and you may need to look at cash flow management.

The second way to calculate operating cash flow is by using the indirect method, which is more common and accrual-based. This is more complex but takes into account changes in assets and liabilities, as well as non-cash expenses. The formula to calculate the indirect method is listed later in this article.

What are cash flow operating activities

Cash flow from operating activities shows how much money a business brings in from regular business pursuits, whether that’s selling goods, manufacturing, or providing a service to customers.

It focuses only on the core business and does not include long-term capital expenditures or investment revenue and expenses. Examples of cash flow from operating activities include cash receipts from:

• collection of receivables
• sale of goods and services
• lawsuit settlements
• licensees
• settlement of insurance claims
• supplier refunds

This type of cash flow is crucial as it enables businesses to pursue opportunities that may enhance shareholder value. Without this cash, it's difficult to reduce debt, make acquisitions, develop new products or pay dividends.

Operating cash flow vs free cash flow

Operating cash flow and free cash flow are both key for comprehensively assessing your business's financial health, but they tell different stories, serving different purposes.

Operating Cash Flow

Operating cash flow (OCF) measures the cash generated by your business’s core operational activities. It focuses on the cash inflows and outflows directly related to the company’s primary operations, such as sales revenue and operating expenses. 

OCF is a key indicator of whether a business can generate enough cash to maintain and grow its operations. It excludes cash flows from investment and financing activities, focusing instead on how well your business is generating cash from day-to-day operations.

Free Cash Flow

Free cash flow (FCF) takes the concept of operating cash flow a step further by considering capital expenditures. 

FCF represents the cash available after a company has made necessary investments in its business operations, such as purchasing equipment or real estate. It shows how much cash is left over after maintaining and expanding the business, indicating the company’s ability to generate cash that can be used for dividends, debt reduction, or other investments.

How to calculate operating cash flow

As mentioned previously, there are two common ways that businesses can calculate operating cash flow. The first one is the direct method, which is used in cash-based accounting. The formula for the direct method is:

Direct method: operating cash flow = total revenue - operating expenses

The indirect method, which is more common, takes several other factors into account. While it is more complex to calculate, it also considers non-cash considerations such as depreciation and amortisation. The formula for the indirect method is:

Indirect method: operating cash flow = net income + non cash-expense +/- changes in assets & liabilities.

You’ll need to make adjustments for depreciation, increases in accounts receivable, and other non-operating and non-cash expenditures from your net income. You should also use data from the same accounting period, or you’ll likely get inaccurate results.

How to Calculate Your Operating Cash Flow Ratio

Understanding your operating cash flow (OCF) ratio measures how well the cash generated from your core operating activities covers your business’s costs, showing you a view of your company's financial stability and efficiency.

What is an Operating Cash Flow Ratio?

The operating cash flow ratio measures how efficiently you generate and manage cash relative to the size of your liabilities. 

A higher OCF ratio indicates that your business can cover more of its financial obligations with current earnings, suggesting greater financial stability.

This metric is valuable for various stakeholders, such as investors and creditors, as it helps them better understand your financial position. Internally, it aids in decision-making about potential investments, expansions, or acquisitions by providing a clearer picture of your cash flow capabilities.

For example, if you plan a significant expansion or acquisition, examining your OCF ratio helps determine whether you have the necessary cash to fund it. It also offers insights into your accounts receivable process. If you're having difficulty collecting payments, your operating cash flow will suffer, indicating a need to improve your credit control strategies.

How to Calculate Your Operating Cash Flow Ratio

To calculate your company’s operating cash flow ratio, use the following formula:

Operating cash flow = net cash from operations ÷ current liabilities.

An ideal ratio should be greater than 1:1. For example, if net cash flow from operations is £100,00 and current liabilities is £80,000, the ratio would be 1.25:1.  

A ratio below 1 means that a business spends more than it makes from its operations and is likely to be experiencing cash flow problems. The higher the number is, the more cash your business is making.

How to improve cash flow from operations

There are several ways you can improve cash flows from operations, including:

• collecting on overdue invoices
• offering discounts to incentivise early payments
• increasing your inventory turnover
• paying suppliers on time
• carrying out customer credit checks
• raising your prices
• forming a buying cooperative
• collecting business payments more easily with iwocaPay.

Boost Your Cash Flow an iwoca Flexi-Loan

If you’re facing challenges in maintaining a positive cash flow, iwoca’s Flexi-Loan could be the solution for you. Our Flexi-Loan offers quick access to funds with flexible terms, helping you bridge cash flow gaps, cover unexpected expenses, and invest in growth opportunities.

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