Operating Cash Flow Calculator

Profit is an opinion, cash is a fact

A company can be profitable and still run out of money. It happens often enough that it has become the standard cautionary tale in business, and the reason is that profit and cash are measured differently.

Profit records a sale when you make it. Cash records it when the customer actually pays. If those are ninety days apart, and you have already paid your supplier and your staff, you can be sitting on a healthy income statement and an empty account.

Operating cash flow measures the second thing. It starts from net income and adjusts for everything that was counted as profit without moving money, and everything that moved money without being counted as profit.

Eight fields, one result, and one thing to get right before you use it, which is the sign on three of those fields.

Eight fields

1. Net Income. The bottom line for the period.
2. Depreciation. The charge for the period.
3. Amortization. The equivalent for intangible assets.
4. Change in Inventories. How much stock levels moved.
5. Change in Accounts Receivables. How much customers owe you moved.
6. Change in Accounts Payable. How much you owe suppliers moved.
7. Income Tax Payable. Movement in tax owed but not yet paid.
8. Net of Other Cash Flows. Anything else operating.

The tool adds all eight together. Which means the arithmetic is only as right as the signs you give it, and the next section is entirely about that.

Every figure comes from comparing two balance sheets, this period against last, except net income, depreciation and amortization, which come from the income statement.

The signs, which decide everything

Read this before you enter anything, because the difference is enormous.

The three working capital fields ask for a change, and a change can go either way. What matters is not whether the balance went up or down, but whether cash came in or went out as a result.

Inventories. Buying more stock spends money. So if inventory rose, that is cash out, and it should be entered as a negative. If you ran stock down, you converted it to cash, and that is a positive.

Accounts receivable. If customers owe you more than they did, you made sales and did not get paid. Cash out, enter as negative. Collecting overdue invoices brings the balance down and the cash in, so that is positive.

Accounts payable. This one runs the other way. If you owe suppliers more, you are holding on to money you have not yet handed over. Cash in, enter as a positive. Paying suppliers down is cash out and belongs as a negative.

Here is the same period entered two ways. Net income 54,000, depreciation 30,000, amortization 6,000, with inventory up 20,000, receivables up 35,000 and payables up 12,000.

A difference of 110,000 on the same period. The first version says the business generated three times its net income in cash. The second says it generated less. Only one of them is true.

The rule in one line: if it took cash out of the business, enter it as a negative.

A profitable company running short of cash

Take the correct version above and read what it says.

The company earned 54,000 and generated 47,000 of cash. Not a crisis, and worth understanding.

Depreciation and amortization added 36,000 back, because neither of them moved any money. That should have pushed cash flow well above profit.

It did not, because working capital absorbed 43,000. Stock went up by 20,000 and customers owed 35,000 more, offset by 12,000 of extra supplier credit.

That is the signature of a growing business. Growth consumes cash before it produces any, and the faster you grow the more it consumes.

Why depreciation gets added back

Depreciation is a cost with no payment attached, which is why it looks strange in a cash calculation until you see what it is doing.

When a business buys a machine for 150,000 with a five year life, the money leaves the bank once, on the day of purchase. But the accounts do not charge the whole 150,000 against that year's profit, because the machine will earn for five years. They spread it, 30,000 a year.

So in years two through five there is a 30,000 charge reducing profit and no money moving at all. To get from profit to cash you add it straight back.

Amortization does the same job for intangible assets: software, patents, purchased goodwill.

Two consequences worth carrying. A capital-heavy business will always show operating cash flow well above its net income, because it has large annual depreciation charges. And the cash actually spent on machines does not appear here at all, since buying assets is an investing activity rather than an operating one. Operating cash flow deliberately shows only what the trading generated.

What growth does to your bank balance

Working capital is the money tied up in running the business, and it moves against you when you grow.

Picture a business that doubles its sales. It has to hold roughly twice the stock. Its customers owe roughly twice as much. Its suppliers extend more credit, but usually not enough to cover both.

All of that happens before the extra profit arrives. Which is why fast growing companies raise money, and why a business can fail in a boom.

Three levers, and they are the same three fields:

Collect faster. Every day you shave off how long customers take to pay releases cash permanently. Getting 35,000 of receivables down to 20,000 puts 15,000 back in the account and it stays there.

Hold less stock. Same logic. The inventory turnover calculator quantifies how long your stock is sitting still, and days of stock translates directly into cash tied up.

Pay suppliers on their terms rather than early. Supplier credit is usually the cheapest funding a business has. Paying a 30 day invoice on day 10 is lending money to your supplier at no interest.

None of these three changes your profit by a single unit. All of them change your cash.

The gap worth watching

Compare operating cash flow against net income across several periods. The relationship between them is more informative than either number alone.

Cash flow comfortably above profit is usually healthy, and usually depreciation doing its work. A business with heavy fixed assets should look like this.

Cash flow tracking profit closely is the ordinary picture for a service business with few assets and quick payment.

Cash flow persistently below profit is the one to investigate. Once or twice it means growth, and growth explains itself. Repeatedly, with flat sales, it usually means receivables are stretching because customers are paying later, or stock is building because it is not selling.

Profit positive and cash flow negative deserves attention immediately. The business is reporting earnings while consuming money, which is only survivable for as long as somebody is funding it.

One habit. Run this each quarter and write down which of the eight lines moved most. Over a year the pattern tells you where your cash actually goes, and it is frequently not where anyone assumed.

This is a measurement of figures you supply rather than an assessment of a business, and nothing here is financial advice.

Questions people ask

How is operating cash flow calculated?

Start with net income, add back non-cash charges like depreciation and amortization, then adjust for changes in working capital and other operating items.

Should I enter working capital changes as positive or negative?

Negative if cash went out. An increase in inventory or receivables is cash out. An increase in payables is cash in and goes in positive. Getting this wrong on the example above changes the answer by 110,000.

Why is depreciation added back?

Because it reduces profit without any money leaving. The cash was spent when the asset was bought, and depreciation just spreads that cost across the years the asset is used.

Why is my cash flow lower than my profit?

Usually working capital. If stock and unpaid customer invoices have grown, cash is tied up in them. It is normal in a growing business and worth investigating when sales are flat.

Does this include money spent on equipment?

No. Buying assets is an investing activity, not an operating one. Only the depreciation of those assets appears here, and it appears as an add-back.

Where do I find these numbers?

Net income, depreciation and amortization come from the income statement. The change figures come from comparing this period's balance sheet against the last one.

Can operating cash flow be negative?

Yes, and it is a serious signal if it persists. It means the trading operation consumed more cash than it produced, which can only continue while somebody funds the shortfall.

How do I improve it without changing profit?

Collect from customers faster, hold less stock, and take the full credit terms your suppliers offer. All three release cash and none of them touches your income statement.

References

The indirect method used here, under which operating cash flow is derived by adjusting net income for non-cash charges and for changes in operating assets and liabilities, is the standard presentation of the cash flow statement. The separation of operating from investing and financing activities, and the requirement that non-operating items be stated separately in the accounts of registrants, follows Regulation S-X. The treatment of depreciation as the spreading of an asset's cost across the periods it is used, and of business expenses generally, follows Internal Revenue Service guidance.

1. United States Securities and Exchange Commission, Regulation S-X (17 CFR 210), including Rule 5-02 for balance sheet captions and Rule 5-03 for income statement line items. Text quoted in SEC staff correspondence at https://www.sec.gov/Archives/edgar/data/0001019361/000101936112000010/filename1.txt
2. Internal Revenue Service, Publication 334: Tax Guide for Small Business. https://www.irs.gov/publications/p334
3. Internal Revenue Service, Publication 538: Accounting Periods and Methods. https://www.irs.gov/publications/p538