Cash Flow From Operating Activities (CFO) Defined, With Formulas (2024)

What Is Cash Flow From Operating Activities (CFO)?

Cash flow from operating activities (CFO) indicates the amount of money a company brings in from its ongoing, regular business activities, such as manufacturing and selling goods or providing a service to customers. It is the first section depicted on a company's cash flow statement.

Cash flow from operating activities does not include long-term capital expenditures or investment revenue and expense. CFO focuses only on the core business, andis also known as operating cash flow (OCF) or net cash from operating activities.

Key Takeaways

  • Cash flow from operating activities is an important benchmark to determine the financial success of a company's core business activities.
  • Cash flow from operating activities is the first section depicted on a cash flow statement, which also includes cash from investing and financing activities.
  • There are two methods for depicting cash from operating activities on a cash flow statement: the indirect method and the direct method.
  • The indirect method begins with net income from the income statement then adds back noncash items to arrive at a cash basis figure.
  • The direct method tracks all transactions in a period on a cash basis and uses actual cash inflows and outflows on the cash flow statement.

Cash Flow From Operating Activities (CFO) Defined, With Formulas (1)

Understanding Cash Flow From Operating Activities (CFO)

Cash flow forms one of the most important parts of business operations and accounts for the total amount of money being transferred into and out of a business. Since it affects the company'sliquidity, it has significance for multiple reasons. It allows business owners and operators check where the money is coming from and going to, it helps them take steps to generate and maintain sufficient cash necessary for operational efficiency and other necessary needs, and it helps in making key and efficient financing decisions.

The details about the cash flow of a company are available in its cash flow statement, which is part of a company's quarterly and annual reports. The cash flow from operating activities depicts the cash-generating abilities of a company's core business activities. It typically includesnet incomefrom the income statement and adjustments to modify net income from an accrual accounting basis to a cash accounting basis.

Cash availability allows a businessthe option to expand, build and launch new products, buy back shares to affirm their strong financial position, pay out dividends to reward and bolster shareholder confidence, or reduce debt to save on interest payments. Investors attempt to look for companies whose share prices are lower and cash flow from operationsis showing an upward trend over recent quarters. The disparity indicates that the company has increasing levels of cash flow which, if better utilized, can lead to higher share prices in near future.

Positive (and increasing) cash flow from operating activities indicates that the core business activities of the company are thriving.It provides as additional measure/indicator of profitability potential of a company, in addition to the traditional ones like net income or EBITDA.

Cash Flow Statement

The cash flow statement is one of the three main financial statements required in standard financial reporting- in addition to the income statement and balance sheet. The cash flow statement is divided into three sections—cash flow from operating activities,cash flow from investing activities, andcash flow from financing activities. Collectively, all three sections provide a picture of where the company's cash comes from, how it is spent, and the net change in cash resulting from the firm's activities during a given accounting period.

The cash flow from investing section shows the cash used to purchase fixed and long-term assets, such asplant, property, and equipment(PPE), as well as any proceeds from the sale of these assets. The cash flow from financing section shows the source of a company's financing and capital as well as its servicing and payments on the loans. For example, proceeds from the issuance of stocks and bonds, dividend payments, and interest payments will be included under financing activities.

Investors examine a company’s cash flow from operating activities, within the cash flow statement, to determine where a company is getting its money from. In contrast to investing and financing activities which may be one-time or sporadic revenue, the operating activities are core to the business and are recurring in nature.

Types of Cash Flow from Operating Activities

The cash flow from operating activities section can be displayed on the cash flow statement in one of two ways.

Indirect Method

The first option is the indirect method, where the company begins with net income on an accrual accounting basis and works backwards to achieve a cash basis figure for the period. Under the accrual method of accounting, revenue is recognized when earned, not necessarily when cash is received.

For example, if a customer buys a $500 widget on credit, the sale has been made but the cash has not yet been received. The revenue is still recognized by the company in the month of the sale, and it shows up in net income on its income statement.

Therefore, net income was overstated by this amount on a cash basis. The offset to the $500 of revenue would appear in the accounts receivable line item on the balance sheet. On the cash flow statement, there would need to be a reduction from net income in the amount of the $500 increase to accounts receivable due to this sale. It would be displayed on the cash flow statement as "Increase in Accounts Receivable -$500."

Direct Method

The second option is the direct method, in which a company records all transactions on a cash basis and displays the information on the cash flow statement using actual cash inflows and outflows during the accounting period.

Examples of the direct method of cash flows from operating activities include:

  • Salaries paid out to employees
  • Cash paid to vendors and suppliers
  • Cash collected from customers
  • Interest income and dividends received
  • Income tax paid and interest paid

Indirect Method vs. Direct Method

Many accountants prefer the indirect method because it is simple to prepare the cash flow statement using information from the income statement and balance sheet. Most companies use the accrual method of accounting, so the income statement and balance sheet will have figures consistent with this method.

TheFinancial Accounting Standards Board (FASB) recommends that companies use the direct method as it offers a clearer picture of cash flows in and out of a business. However, as an added complexity of the direct method, the FASB also requires a business using the direct method to disclose the reconciliation of net income to the cash flow from operating activities that would have been reported if the indirect method had been used to prepare the statement.

The reconciliation report is used to check the accuracy of the cash from operating activities, and it is similar to the indirect method. The reconciliation report begins by listing the net income and adjusting it for noncash transactions and changes in the balance sheet accounts. This added task makes the direct method unpopular among companies.

Indirect Method Formulas for Calculating Cash Flow from Operating Activities

Different reporting standards are followed by companies as well as the different reporting entities which may lead to different calculations under the indirect method. Depending upon the available figures, the CFO value can be calculated by one of the following formulas, as both yield the same result:

Cash Flow from Operating Activities =Funds from Operations + Changes inWorking Capital

where, Funds from Operations = (Net Income + Depreciation, Depletion, & Amortization + Deferred Taxes & Investment Tax Credit + Other Funds)

This format is used for reporting Cash Flow details by finance portals likeMarketWatch.

Or

Cash Flow from Operating Activities =Net Income + Depreciation, Depletion, & Amortization + Adjustments To Net Income + Changes In Accounts Receivables + Changes In Liabilities + Changes In Inventories + Changes In Other Operating Activities

This format is used for reporting Cash Flow details by finance portals likeYahoo! Finance.

All the above mentioned figures included above are available as standard line items in the cash flow statements of various companies.

The net incomefigure comes from theincome statement. Since it is prepared on anaccrual basis, the noncash expenses recorded on the income statement, such as depreciation and amortization, are added back to the net income. In addition, any changes in balance sheet accounts are also added to or subtracted from the net income to account for the overall cash flow.

Inventories,tax assets, accounts receivable, and accrued revenue are common items of assets for which a change in value will be reflected in cash flow from operating activities.Accounts payable, tax liabilities, deferred revenue, and accrued expenses are common examples of liabilities for which a change in value is reflected in cash flow from operations.

From one reporting period to the next, any positive change in assets is backed out of the net income figure for cash flow calculations, while a positive change in liabilities is added back into net income for cash flow calculations.Essentially, an increase in an asset account, such as accounts receivable, means that revenue has been recorded that has not actually been received in cash. On the other hand, an increase in a liability account, such as accounts payable, means that an expense has been recorded for which cash has not yet been paid.

Example of Cash Flow from Operating Activities

Let’s look at the cash flow details of the leading technology company Apple Inc. (AAPL) for the fiscal year ended September 2018. The iPhone maker had a net income of $59.53 billion, Depreciation, Depletion, & Amortization of $10.9 billion, Deferred Taxes & Investment Tax Credit of -$32.59 billion, and Other Funds of $4.9 billion.

Following the first formula, the summation of these numbers brings the value for Fund from Operations as $42.74 billion. The net Change in Working Capital for the same period was $34.69 billion. Adding it to Fund from Operations gives the Cash Flow from Operating Activities for Apple as $77.43 billion.

For the second method, summing up the available values from Yahoo! Finance portal that reports Apple's FY 2018 Net Income $59.531 billion, Depreciation $10.903 billion, Adjustments To Net Income -$27.694 billion, Changes In Accounts Receivables -$5.322 billion, Changes In Liabilities 9.131 billion, Changes In Inventories $.828 billion, and Changes In Other Operating Activities $30.057 billion gives the net CFO value as $77.434 billion.

Both the methods yield the same value.

Special Considerations

One must note that working capital is an important component of cash flow from operations, and companies can manipulate working capital by delaying the bill payments to suppliers, accelerating the collection of bills from customers, and delaying the purchase of inventory. All these measures allow a company to retain cash. Companies also have the liberty to set their own capitalization thresholds, which allow them to set the dollar amount at which a purchase qualifies as a capital expenditure.

Investors should be aware of these considerations when comparing the cash flow of different companies. Due to such flexibility where managers are able to manipulate these figures to a certain extent, the cash flow from operations is more commonly used for reviewing a single company's performance over two reporting periods, rather than comparing one company to another, even if the two belong in the same industry.

Cash Flow From Operating Activities (CFO) Defined, With Formulas (2024)

FAQs

Cash Flow From Operating Activities (CFO) Defined, With Formulas? ›

Here's the formula to calculate a company's net CFO using the indirect method: Net cash from operating activities = Net income +/− depreciation and amortization +/− Change in working capital.

What is the formula for cash flow from operating activities? ›

Because most companies report the net income on an accrual basis, it includes various non-cash items, such as depreciation and amortization. Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital.

What is the formula for cash flow from financing activities? ›

Formula and Calculation for CFF

Add all cash outflows from stock repurchases, dividend payments, and repayment of debt. Subtract the cash outflows from the inflows to arrive at the cash flow from financing activities for the period.

How do I calculate operating cash flow? ›

The simplest formula goes like this:
  1. Operating cash flow = total cash received for sales - cash paid for operating expenses.
  2. OCF = (revenue - operating expenses) + depreciation - income taxes - change in working capital.
  3. OCF = net income + depreciation - change in working capital.

What is the CFO of the cash flow statement? ›

Cash flow from operating activities (CFO) indicates the amount of money a company brings in from its ongoing, regular business activities, such as manufacturing and selling goods or providing a service to customers. It is the first section depicted on a company's cash flow statement.

What are examples of operating activities? ›

Operating activities examples include:
  • Receipt of cash from sales.
  • Collection of accounts receivable.
  • Receipt or payment of interest.
  • Payment for materials and supplies.
  • Payment of salaries.
  • Payment of principal and interest for operating leases. ...
  • Payment of taxes, fines, and license costs.
Apr 11, 2023

What is CFO vs CFI vs CFF? ›

Of these, the cash flow statement presents a substantial understanding of a company's financial health. It comprises three sections – CFO or cash flow from operations, CFI or cash flow from investing activities, and CFF or cash flow from financing activities.

What is the formula for monthly cash flow? ›

All types of cash flow formulas explained
Monthly cash flow balance= Monthly inflows - Monthly outflows
Investing cash flow= Incoming investment cash flows - outgoing investment cash flows
Financing cash flow= Incoming financing cash flows - outgoing financing cash flows
4 more rows
Oct 4, 2022

What is the formula for free cash flow to equity from cash flow from operations? ›

FCFF and FCFE can be calculated by starting from cash flow from operations: FCFF = CFO + Int(1 – Tax rate) – FCInv. FCFE = CFO – FCInv + Net borrowing.

What is the FCF formula for CFO CapEx? ›

Free cash flow (FCF) equals cash from operations (CFO) minus capital expenditures (CapEx).

How do you calculate CFO direct method? ›

Under the direct cash flow method, you subtract cash payments, such as payments to suppliers, employees, cash receipts operations and customer receipts, during the period. This determines the net cash flow from the company's operating expenses.

What is the cash flow from financing ratio? ›

The cash flow coverage ratio measures how much cash you generate annually to pay off your total outstanding debt. A ratio of greater than one indicates that you're not at risk of default. Because this ratio shows sufficient cash flow to pay off debt plus interest, it should be as high as possible.

What is cash flow from investing and financing activities? ›

Cash flow from investing activities involves long-term uses of cash. The purchase or sale of a fixed asset like property, plant, or equipment would be an investing activity. Also, proceeds from the sale of a division or cash out as a result of a merger or acquisition would fall under investing activities.

How cash flows from investing and financing activities are determined? ›

Analyze the changes in assets that are not operating assets to determine cash inflows and outflows from investing activities. Analyze the changes in liabilities (that are not operating liabilities) and stockholders' equity accounts to determine cash inflows and outflows from financing activities.

References

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