What is operating cash flow?

Operating cash flow is the cash a business brings in from selling its products and services, minus recurring operating expenses like payroll, rent and inventory. Positive operating cash flow means a business is bringing in more cash than it spends. Negative operating cash flow may mean a business has to rely on savings or new debt to sustain itself.

Understanding and calculating operating cash flow is important for measuring and tracking overall business health and for insight into business decision-making.

Why does operating cash flow matter?

Operating cash flow indicates how well business operations are working and what actions make sense for a business to take. For example, a coffee shop bringing in enough revenue each month to cover rent, employee wages and supply costs with cash left over has positive operating cash flow. Based on this, it might choose to hire staff or add new items to the menu.

On the other hand, a construction company that lands plenty of jobs but can't typically cover payroll and equipment expenses is facing negative operating cash flow. It might need to raise prices, cut costs and take other steps to improve operations and avoid a cash flow crunch before it hits.

Here are some of the reasons operating cash flow is important:

1. Helps avoid cash crunches
Tracking operating cash flow helps spot early signs of trouble. Advance notice of slow payments or cost increases provides time to act before cash flow trouble hits.

2. Informs decision-making
The health of cash flow may inform the best timing for hiring, buying inventory or expanding. Operating cash flow may also indicate where a business may need to focus attention. Issues with operating cash flow may mean a business needs to speed up collections, slow bill payment, increase prices, shift sales focus or take other steps.

3. Makes a business attractive
Healthy operating cash flow is appealing to lenders, investors and partners. It may result in better terms and more opportunities.

Understanding and calculating operating cash flow

Learning to calculate operating cash flow requires understanding relevant terms, the formula, and how it's different from other important financial metrics.

Three key terms are important for calculating operating cash flow:

• Net income: The profit a business makes after paying expenses, taxes and interest, based on what's recorded in financial statements, not actual cash moving in or out of a business.
• Non-cash expenses: Costs like depreciation and amortization that count as expenses but don't actually use up cash.
• Working capital: The difference between what a business owns short-term (like cash and inventory) and what it owes short-term (like bills and loans). Changes here can affect how much cash is available day to day.

Calculating operating cash flow

There are two ways of calculating operating cash flow, indirect and direct. Both arrive at the same number, but the difference is in the approach used to get there.

The indirect method starts with net income and adjusts for things like unpaid bills, customer invoices and non-cash expenses. This is important since operating cash flow needs to reflect the actual flow of cash and profit alone may not capture it. This is the most widely used approach.

Indirect operating cash flow formula:

Net Income + Non-Cash Expenses + Changes in Working Capital = Indirect Operating Cash Flow

The direct method calculates operating cash flow by showing the actual cash collected from customers and the cash paid to suppliers, employees and others. It gives a clear view of day-to-day cash movement but is less commonly used since it requires tracking cash and payments individually, rather than starting with net income, which most businesses already calculate.

Direct operating cash flow formula:

Cash received from customers - Cash paid to suppliers - Cash paid to employees - Other operating cash payments = Direct Operating Cash Flow

Operating cash flow vs. other key business metrics

Understanding how operating cash flow is different from other calculations in your business can help you use it to best advantage. This table compares operating cash flow to four other metrics.

How to improve operating cash flow

Since operating cash flow measures how well a business is generating cash to cover expenses, timing is everything. Consider these steps to enhance the timing of cash inflows and outflows.

1. Speed up customer payments
Encourage faster payments from customers by sending customized invoices to clients and by accepting credit, debit, and electronics payments such as ACH and RTP. Also, consider accepting digital payment through tools such as Zelle®¹. Use mobile check deposit² to quickly access funds once you receive them.

2. Hold on to cash as long as possible
Use online payment tools to time payments close to when they are due and maximize the amount of time cash stays in your account. Also lean on tools that help you pay quickly such as electronic and digital payments. For larger or international payments, use domestic and international wire transfers to move money speedily and securely. When possible, negotiate longer payment terms with suppliers.

3. Improve cash flow management
A cash management system can ease the task of tracking, categorizing and analyzing cash as it moves in and out of a business. Use a cash management system to track and categorize payments so that you can identify which customers are paying slowly and take action. A tool may help gather cash flow insight that can inform decisions, help with forecasting, and reveal where adjustments need to be made to improve cash flow.

4. Emphasize high margin offerings
Operating cash flow may improve if you identify and focus on the products and services with the highest profit margin. Focusing on increasing sales of these items can strengthen operating cash flow.

Operating cash flow: An essential input to actions and timing

Since operating cash flow shows how well a business is generating cash to cover its expenses, it holds the key to what steps a business should take and when. Positive operating cash flow supports potential investment and business growth. Negative operating cash flow is a sign that prices, expenses or efficiency needs adjustment. Cash management tools can make the process of tracking and analyzing cash flow an easier part of a company's routine.

Ready to take your business to the next level? Citizens is here to help with cash management solutions to help facilitate cash flow and keep your day-to-day business operations running smoothly.