What is Operating Cash Flow Ratio (OCF)?
In accounting, it is a measure for amount of cash generated by a company's normal business operations. Operating cash flow is important because it indicates whether a company is able to generate sufficient positive cash flow to maintain and grow its operations, or whether it may require external financing.
Operating cash flow (OCF) is not the same thing as net income, but is derived from net income through a series of adjustments to working capital accounts on the balance sheet. This is an accountant’s way of saying that OCF details how cash flows into and out of a company. If more flows in than out, the flow is positive, if not, the flow is negative.
OCF is calculated by adjusting net income for items such as depreciation, changes to accounts receivable and changes in inventory.
| OCF = EBIT + Depreciation - Taxes
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Interest is an operating flow. Since it adjusts for liabilities, receivables, and depreciation, operating cash flow is a more accurate measure of how much cash a company has generated (or used) than traditional measures of profitability such as net income or EBIT.
Significance of OCF
The sources and uses of cash could be broken down into following categories
1. Operating activities:
Good thing about operating cash flow is that it prevents companies from manipulating financial information. With net income, companies have some flexibility that allows them to manipulate this number. Operating cash flow is not something that can be manipulated by company accountants. When the financial statements are released by the company, investors can calculate the operating cash flow without any troubles.
2. Financing activities:
Reports cash level changes from the purchase of a company’s own stock or issue of bonds, and payments of interest and dividends to shareholders.
The Bottom Line
Operating cash flow is just one component of a company’s cash flow story, but it is also one of the most valuable measures of strength, profitability and the long-term future outlook. It is a good sign when a company has strong operating cash flows with more cash coming in than leaving. Companies with strong growth in OCF most likely have more stable net income, better abilities to pay and increase dividends, and more opportunities to expand and weather downturns in the general economy or their industry.
If you think “Cash is King,” strong cash flow from operations is what you should watch for when analyzing a company.
We will explain other Ratios like Current Ratio and Quick Ratio which Fund Managers usually use while evaluating stocks in the next edition on Mirae Asset Knowledge Academy Tutorials.
Mutual fund investments are subject to market risks, read all scheme related documents carefully.