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Operating Cash Flow | The Core of your Business

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Operating Cash FlowWhat is Operating Cash Flow?

Operating Cash Flow (OCF) is cash relating to core business activities over a given period. Ideally, you want the cash coming into the business, generated from your service offering (i.e. sales) to be more than operating costs. 

OCF is used to evaluate the underlying health of the business and to demonstrate the cash generated from normal operations, without taking into account secondary sources of revenue, such as investments, finance or the sale of assets.

Operating activities explained

The various sources and application of cash which would be included in your OCF are those which are directly related to providing your goods and services to the market. These include but are not limited to:

  • Receipts from sales
  • Payments made to suppliers
  • Tax payments (GST and PAYG)
  • Any interest payments or finance costs
  • Employee wages (including PAYG)
  • Rent for business property
  • And any other income or expenses relating to the daily activities of a company, i.e. overheads, fuel tax credits, etc.
  • How to calculate Operating Cash Flow

Your business can typically generate cash from three sources; normal operating activities, cash injected from investing (equity, shareholders), and cash from financing (debt).

OCF is calculated by adding Net Income (revenue – cost of sales) to Noncash Expenses (typically depreciation), plus changes in working capital (debtors, creditors, stock, cost of goods and work in progress).

OCF = Net Income + Noncash Expenses + Change in Working Capital 

Net Income: Amount of revenue left after cost of sales, less expenses and other deductions are taken out.

Noncash Expenses: An accounting expense, such as depreciation, amortization, movement in asset values, stock-based compensation, and asset impairments.

Change in working capital: is the change in current assets (cash in the bank, debtors, stock and work in progress), minus the change in current liabilities (creditors, tax).

Note: Collection of debtors is crucial. You can assume normal trading terms, however in reality collection of invoices is often delayed.

Purpose of Operating Cash Flow 

Cash flow and having adequate working capital available is what keeps the business going. It allows you to pay obligations, commitments when they fall due and to invest in your business growth.

Without positive cash flow, businesses will need to source cash from other sources such as those mentioned above (equity or finance). Having a negative OCF from time to time is ok, but if you continue on a negative path over consecutive months/years, you’re essentially using cash from equity or financing activities to pay for your losses. Overtime, this will have a huge impact on your business and may even force you to make tough decisions, such as closing the doors, or becoming insolvent.

It’s important to note that OCF should not be used as an overall financial analysis of the business and should in fact be used in conjunction with other metrics to ensure an accurate understanding of the business.

Benefits of understanding your business’ Operating Cash Flow

  • Allows you to understand your core business’s profitability, strengths and weaknesses
  • Allows you to understand the long-term outlook of your business so you can forecast and budget
  • A positive OCF allows you to attract further equity or will give you confidence to invest further in your business

Manage your Operating Cash Flow with a well-structured 3-way forecast

If you’re unsure of your business’s performance, especially during these uncertain times, know that you’re not alone. A well-structured 3-way forecast and having the ability to fully understand your business’ cash flow is more important than ever. 

At Ledge, we have a number of trusted strategic partners who can analyse your business and formulate a 3-way forecast, which takes into account your cash flow, balance sheet and profit and loss statement, to create a financial forecast suited to your business.

If this article has sparked questions surrounding your businesses OCF and overall performance, please contact your Ledge Finance Executive directly, or contact our offices here and we will do our best to assist you through these challenging times.


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