Operating cash flow, represented on the cash flow statement, refers to the income that flows in and out of a business due to its operational income and expenses. Learn how operating cash flow works, how it is used, and how you can calculate taxes from it.
How Do You Use Cash Flow Information?
Cash flow refers to the way in which money flows into and out of a business, and operating cash flow is cash flow that is connected with operating activities. Operating cash flow is useful for helping executives track their business’s financial health so they can make decisions on how it will operate. Management can determine whether the business can afford its expenses, and whether they need to make changes. Cash flow is also used to prove a business’s creditworthiness to lenders and investors.
How To Calculate Taxes in Operating Cash Flow
Operating cash flow refers to the money that goes in and out of a business due to income and expenses related to its operations. Operating expenses are normal expenses required to run the business, such as payroll and costs of materials to manufacture products. A positive operating cash flow helps ensure the business can afford to continue its operational duties and grow. Otherwise, it may need financing.
Operating Cash Flow Formula
The operating cash flow of a business can be calculated using the following formula: Operating Cash Flow = EBIT + Depreciation – Taxes EBIT refers to the earnings before interest and taxes. This is the amount the business made from its revenue minus the operating expenses. To determine the operating cash flow, the business must track its depreciation of assets used for operations and add this amount to its EBIT. After this has been calculated, it must deduct the amount of taxes owed to reach the operating cash flow. For example, if a business earned $500,000 in revenue and incurred operating expenses consisting of salaries, materials, and equipment of $400,000, then the $400,000 is deducted from the $500,000 to find the EBIT, which is $100,000. If depreciation was $60,000, but taxes owed were $75,000, the operating cash flow calculation would be: Operating Cash Flow = $100,000 + $60,000 - $75,000 So, the company would have $85,000 of operating cash flow. Typically, a business calculates its taxes due by multiplying the tax rate by the amount of taxable income made by the business. By analyzing the operating cash flow equation, a business can determine how tax is impacting the amount of cash flowing into the business.
Limitations of Cash Flow
Cash flow analysis has its limitations when it comes to determining the value and success of a business. A cash flow statement only looks at the income and expenses that flow in and out of a business. It doesn’t include other assets of the business that can bring value, such as equipment and intellectual property. It doesn’t account for any other factors that could impact its growth, such as intangible assets like reputation and customer base, nor does it reflect whether the money flowing comes from a loan. Cash flow is not the only indication of its potential growth and development. Metrics on other financial statements such as the income statement and the balance sheet also provide key information. Keep in mind that cash flow is not the same as profitability, which is another key indicator of a business’s financial strength. They are separate metrics showing different perspectives of the business. A business can have a positive cash flow but not profit, or it can generate a good profit and still have a negative cash flow.
The Bottom Line
Cash flow analysis is used for a variety of reasons because it provides insight to the financial health of the business. Operating cash flow is specific to the activities having to do with the operations of the business. Understanding how to use the operating cash flow equation to determine how taxes are impacting the cash inflow can help business executives make financial decisions. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
