Definition: Cash flow from operations, also called operating cash flow, refers to the amount of cash garnered from a business’ core activities. This is typically calculated by taking a company’s net income, factoring in depreciation expenses, then adjusting for any gains or losses on sales and assets.
What Does Cash Flow From Operations Mean?
What is the definition of cash flow from operations? In laymen’s terms, cash flows from operations calculates how much money companies made from all the services and goods they sold or provided independent of their depreciation expense. This total is then adjusted to account for any changes in the value of the currency.
Companies tend to view operating cash flow as a more accurate metric for determining how well the business is really doing. A business could potentially have well over $100,000 in net income, yet have a cash flow that is substantially higher or lower than that amount. This is because after the net income is calculated, the depreciation expense is added to the net income total. This is done because net income is calculated to include accrued accounts and the cash flow metric looks at profits on a cash basis to see how much cash came in the door and how much went out during the year.
Thus, any paper expenses like depreciation and amortization must be added back in and any changes in asset and liability accounts must be adjusted for their effects on the cash balance of the company.
Let’s take a look at an example.
Example
Johnny runs company XYZ. Johnny’s company calculates that he has made $200,000 in net profit this year. Johnny now wants to calculate his cash flows. He first calculates his depreciation expenses by adding together all the used expenses such as building rental, machinery etc., that were purchased in that fiscal year. This amount totaled to about $40,000, which he adds to his net profit total to arrive at $240,000. He then begins to subtract all increases in assets accounts like accounts receivable and inventory increases, which totaled $40,000. Then he adds all losses that occurred through the sale of assets and accounts payable, which totaled $50,000.
To summarize, the company’s income statement and balance sheet include the following:
- Depreciation: $40,000
- Net Income: $200,000
- Increase in assets: $40,000
- Decreases in assets and increases in liabilities: $50,000
The cash flows from operations formula is calculated like this:
$200,000 + $40,000 – $40,000 + $50,000 = $250,000
Thus, Johnny should successfully calculate his operating cash flow to be $250,000 for the year.
Summary Definition
Define Cash Flow From Operations: OCF means the net money that was generated from a business’ operating activities.
