A company's operating cash flow is the amount of cash which has been generated from its regular business operations. This serves as an excellent measure of the performance of the company's core business strength and how it is evolving over time. The company's operating cash flow is vital as it represents a company's ability to generate profitability, fund expansion and capital expenditures and purchase inventory going forward.
A company which is generating significant operating cash flow, usually also does not need to incur large amounts of debt as it has enough free cash flow to support its business requirements. Here are some crucial factors to understanding operating cash flow:
- Operating cash-flow includes various non-cash charges which are not counted in terms of calculating net income. This includes stock-based compensation, depreciation & amortisation and other expenses.
- Operating cash flows concentrate on cash generated by a company's main business activities. This includes selling and purchasing inventory or changes in the value of the inventory. Operating cash flows are also generated by the company's investments and accounts payable.
Importance of Operating Cash flow
There are a number of fundamental reasons why operating cash flow is extremely important in terms of calculating a firm's intrinsic earning power. These include:
- Removing accounting charges which do not accurately represent the earning power of a business. For example, adding back depreciation and amortisation helps to provide a more accurate depiction of the quality of business operations.
- Removing extraordinary earnings/losses. These are not representative of the normalised earning power of a firm and may distort the firm's net income for a given period, providing an inaccurate analysis of the business. As operating earnings measure the firm's recurring income, investors can have confidence in the ability of a firm to continue to generate significant amounts of cash flow in the future.
- Comparing revenue generated to expenses incurred. This enables a clearer picture to be developed regarding how the firm is able to generate free cash flow, which can then be distributed to shareholders.
When operating cash flow is analysed in conjunction with the firms investing and financing activities, a complete picture is able to work out how the business will evolve over time. Additionally, referring to the discussion from management provides more precise insight than simply looking at the income generated.
