Can You Tell Us What Your Business’ Operating Cash Flow Is Right Now?

Can You Tell Us What Your Business' Operating Cash Flow Is Right Now?

You’ve probably heard it before, but it bears repeating: Cash is king, especially for small businesses. You have to have cash to take care of the fundamentals of your business such as running day-to-day operations, paying employees and making the investments you need for growth. So it’s crucial for you to know how much cash your business actually has to work with at any given time.

What Is Operating Cash Flow?

Operating cash flow (OCF) measures the amount of cash — available funds — that a business has on hand related to its everyday operations. Operating cash flow is made up of inflows (money coming into the business) and outflows (expenditures) related to core revenue-generating business activities. These activities can include events such as:

  • Making sales
  • Purchasing inventory
  • Spending on services
  • Paying bills or taxes

Measuring your operating cash flow shows you whether you have enough cash to run your business, and whether you are generating more cash than you are spending overall.

Calculating your net operating cash flow gives you a very realistic look at your business because it only deals in real transactions: money that has actually entered or left your accounts. In contrast, your income statement or profit and loss statement (P&L) may include non-cash transactions, like payments owed to you that have not been made yet or depreciation of assets.

Why Operating Cash Flow Is Important

Operating cash flow is a key indicator of the health of your business and its chances for future success. Positive net cash flow from operations means that your business is generating enough money to sustain itself (and then some), and that your business model is working the way it should. Short-term negative cash flow can be successfully managed, but positive net operating cash flow should be the goal for any business.

Even if a business is profitable, a chronic lack of positive operating cash flow can be a cause for concern. This situation can mean that the business is making its money from sources other than its core business activities, which may not be sustainable long-term.

Factors That Affect Your Operating Cash Flow

Timing is a huge element of cash flow. In many core business functions, there can be a disparity in the timing of when an event occurs (you make a sale to a customer) and when the related cash transaction takes place (your customer pays for your product or service).

Payment terms between you and your customers (as well as between you and your vendors) can have a big impact on cash flow. For example, if your customers get 90 days to pay you for purchases, but you are paying your vendors in 30 days, that will affect your net cash flow in each of those periods.

Tying up your cash in large amounts of inventory, ramping up spending to facilitate growth, declining sales or rising bills can also affect your operating cash flow.

Other Kinds of Cash Flow

Besides operating cash flow, there are two other categories of cash flow: investing cash flow and financing cash flow.

  • Investing cash flow: Includes inflows and outflows related to investments in fixed and long-term assets such as equipment or property, including the sale of these assets.
  • Financing cash flow: Includes inflows and outflows related to financing activities. These might include income from loans or other capital contributions, proceeds from issuing stocks or bonds or dividends to shareholders, for example.

All three categories are used in determining your overall cash flow, but if you are focusing on just your operating cash flow, you will exclude transactions in the other two categories.

Calculating Your Operating Cash Flow

At its most basic, your net cash flow, or the amount of cash on hand at the end of the period, consists of the difference between your operations inflows and outflows. This can be calculated per week, month or quarter depending on your needs. The cash-flow calculation will only include cash transactions that actually occurred during the period.

If your generated cash is more than your expenses, you have positive cash flow. You have negative cash flow if your spending exceeds the amount of money brought in.

Direct vs. Indirect Cash-Flow Calculation Methods

There are two common ways to calculate your operating cash flow: the direct method and indirect method.

Direct Method

With the direct method, you calculate your cash flow for the period based on cash receipts for operations income and payments, including transactions such as cash payments to suppliers and vendors, payments received from customers, payments to employees or tax payments. Adding these together results in your net operating cash flow.

Indirect Method

The indirect method uses your income statement to calculate net cash flow. In this method, you use the net income number from your income statement as a starting point, and then adjust for items that were used to calculate net income but did not affect cash.

This means that non-cash expenses such as depreciation or amortization are added back to the net income number. Further adjustments are made for changes in items such as inventory and accounts receivable or accounts payable. For example, if inventory decreased during the period, it means that it was sold and cash was received, so the amount would be added back to the net income number to increase it.

Forecasting Operating Cash Flow

When you track operating cash-flow events that have already occurred, you can see your cash-flow position at the present moment as well as general trends in your cash-flow history.

The next step is to forecast what your cash flows will look like in the future. This requires some educated guessing, and your projections may not always be 100 percent accurate. But it can offer an idea of the cash-flow challenges you might face and give you time to come up with solutions to cash-flow issues. These can include such measures as negotiating better credit terms with customers and vendors, using credit cards or taking out a business loan.

Going With the Flow

It’s important for your business to know how to check on your operating cash flow at any given moment. When you can clearly see where you are in your cash-flow cycle, you can make much better decisions — both day-to-day and long-term — for the future of your business.

How do you track cash flow? Let us know on Twitter @Revenued_com.

Jennifer Sokolowsky writes about finance, legal and tax topics for publications and companies including The Puget Sound Business Journal, Avalara, and Avvo.
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