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What You Should Know about Operating Cash Flow

Today we’re going to take a look at operating cash flow, which is one of the most important numbers in a company’s accounts. Many investors pay a great deal of attention to these figures as it gives vital clues to an investor trying to assess the health, and value of a company.

What does Operating Cash Flow Means?

It’s simply the amount of cash that company generates from its normal operations. For example, if you are a retailer like Walmart, the bulk of your revenue will come from the difference between the sale price of an item, and how much it costs you to sell it.

The operating cash flow shares a lot of similarities with E.B.I.T.D.A., that’s earnings before interest taxes, depreciation, and amortization. And typically these numbers are not hugely different, that’s why I say they’re very similar.

The difference is due to working capital. I can assume you know what working capital is. One of the problems with learning accounting is that you have to learn multiple things at once. Eventually you will piece it all together.

Working Capital

So let’s take a very quick look at working capital. Working capital is the difference between current assets and current liabilities. The word current simply means that it should be off the company’s books within a year. So a current asset is something that is expected to be sold or consumed within one year.

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Now, we can see the formula. Operating cash flow equals the net income plus non-cash expenses. This is typically depreciation and amortization, mainly let’s add our power of E.B.I.T.DA., plus changes in working capital.

That’s the fundamental formula for operating cash flow


Working Capital = Current Assets – Current Liabilities = Net Income + Non-cash Expenses + Changes in Working Capital = FUNDAMENTAL FORMULA FOR OPERATING CASH FLOW.

Some Applications and How this is Useful to an Investor.

Working capital is very useful; the main use is that;

It can reveal dodgy accounting. For example; a company may generate huge profits but very little cash flow. This may indicate a problem, and you should be very skeptical about the source of the profit when it is not backed up by strong cash flows.

It gives you a more realistic idea of a company’s health. Consider a retailer that owns its own stores, if the property market rockets, the company will report huge profits. But its flow of cash won’t be huge. So when you go into those numbers, and analyze them, you’ll see that the core business is not nearly as profitable as the overall profit figures would indicate. The other thing you need to be aware of is that

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A company’s cash flow is what is used to expand its business. So a company that is not generating much cash flow will need to get its expansion capital from somewhere else. Usually a bank.

Finally, now that you know what operating cash flow is, you can’t just believe the statements figures. There are tricks that companies have used to make their numbers bigger. The classic one is extending the time taken to pay suppliers while collecting the money that’s owed to you faster. You see how that would increase the operating numbers? Think of it. You’re bringing in money faster and paying out slower. It’s really a farce, but it gives the illusion of a higher operating numbers. So hopefully you understand the basic ideas.

By Isaac Alston



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