Accounting Question - For any company, using generally accepted
accounting principles, how do you define the company's "Operating Cash
Flow"?

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Request for Question Clarification by pafalafa-ga on 25 Dec 2003 07:58 PST

Hello mach5555-ga, and Season's Greetings to you.

Please have a look at this site on cash flow prepared by the US Small
Business Administration:

http://www.sba.gov/starting_business/financing/preparecashflow.html

In particular, there is a section on operating cash flow:

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To determine operating cash flow, you start with net income and add
back expenses which did not result in inflows or outflows of cash. The
most common non-cash expense is depreciation. When working with
historical figures, adjusting net income with depreciation and other
non-cash expenses is much simpler than determining all the revenues
and expenses which require or provide funds.

Next, you identify all the balance sheet accounts that are associated
with operations and determine the change in the account from the end
of the last period to the end of the current period. What balance
sheet accounts are we referring to? Let's take another look at the
operating cycle to see what accounts to include.

Operating cash flow will include all the balance sheet accounts that
are a part of normal operations. Trade receivables and payables as
well as accrued expenses, prepaid expenses and other current assets
that are a part of day-to-day operations are included in operating
cash flow as we'll show in the example...

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Is this the level of detail you need, or are you looking for something
more extensive.  If the SBA material works for you, I will be glad to
extract the relevant information and examples from their site and post
it here as an answer to your question.

Let me know what you think.

All the best.  

pafalafa-ga

Hello mach5555-ga:

Although, pafalafa-ga has provided a very nice link but I undertook
this assignment because we get confused in calculating the operating
cash flow due to the different methods of calculation in accounting
and finance. Let me provide a very simple explanation of the two.

Before discussing how to calculate Operating Cash Flow (OCF), let us
first see what we mean by ?cash flow?? By cash flow we simply mean the
difference between the number of dollars that came in and the number
that went out of the company.

A simple example of cash flow is the cash that is paid to creditors
and stockholders (cash outflow) and cash that is generated by selling
goods (cash inflow).

*WARNING!  The standard accounting financial statement, ?Statement of
Cash Flows? is concerned with somewhat different issue and should not
be confused with cash flow and operating cash flow.

OPERATING CASH FLOW

Operating cash flow can simply be described as the cash flow that
results from the firm?s day to day activates of producing and selling.

Note the difference between the definition of cash flow and operating
cash flow. Cash flow consists of cash that comes in and goes out of
the company while operating cash flow consists of the cash that comes
in and out of the company from the firm?s daily activities of
producing and selling.

Confused? Ok! You will understand the difference as we try to
calculate the operating cash flow of a company.

CALCULATING OPERATING CASH FLOW

Let us assume that the Income Statement of the US Corporation looks likes this:

US Corporation
2003 Income Statement
($ In Millions)

Net Sales					$1,509
Cost of goods sold		    	    	   750
Depreciation			       	       	    65
                                                   ___                     
Earnings before Income & Taxes 		       $   694
Interest Paid				   	    70
                                                   ___                     
Taxable Income				       $   624
Taxes					     	   212
                                                   ___                     
Net Income				       $   412

Dividends		                 $103
	Addition to retained earnings     309

OPERATING CASH FLOW ACCRODING TO ACCOUNTING DEFINITION

In Accounting, the operating cash flow can simply be calculated as Net
Income plus depreciation. Thus, from above example the operating cash
flow of the US Corporation is $412 + $65.

Note that we add the depreciation expense of $65 because we didn?t pay
any cash nor we got any cash from anyone, therefore there was no cash
inflow or outflow.

OPERATING CASH FLOW ACCRODING TO FINANCIAL DEFINITION

Here is the formula for calculating operating cash flow according to
financial definition.

Earnings before Income & Taxes
+ Depreciation
-  Taxes
------------------
Operating Cash Flow

To calculate the operating cash flow (OCF), we first need to calculate
revenues (or Net Sales in some cases) minus the costs.

Notice that costs means everything that we pay in cash (cash outflow).
But in order to calculate the operating cash flows we don?t include
depreciation expense and interest expense as a cost.

Why? Because we don?t pay cash to anyone while calculating
depreciation expense, therefore it is not a cash outflow. We also
don?t include interest expense because interest is paid out when we
finance anything and since the cash we pay as an interest does not
originates from the daily activities of buying and selling.

Yes, we include taxes because taxes are paid in cash and originate
from the daily activities of the firm.

Now let us calculate the operating cash flow of US Corporation (see
sample income statement, above).

We know that the Earnings before Income and Taxes are 694 Mil. We will
than add depreciation which is 65 Mil (We add depreciation from the
balance sheet because we didn?t pay anyone cash). Finally we will
deduct taxes that are 212 Mil.

US Corporation
2003 Operating Cash Flow

Earnings before Income and Taxes		 $694
+ Depreciation					   65
- Taxes						  212
						____
	Operating Cash Flow			$547

DIFFERNCE BETWEEN ACCOUNTING AND FINANCIAL OPERATING CASH FLOW.

The only main difference between the accounting and financial
operating cash flow definition is that the interest is not considered
to be an outflow of cash.

WHY CALCULATE OPERATING CASH FLOW?

On a very basic level, an operating cash flow tells us whether or not
a firm?s cash inflows from its business operations are sufficient to
cover its cash outflows. Therefore, a negative operating cash flow is
often a sign of trouble.

I hope this will help. Please clarify, if you are not satisfied. I
will explain everything that is needed to be explained.

Sincerely,
Leader-ga.

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Clarification of Answer by leader-ga on 25 Dec 2003 10:30 PST

I am sorry for a missing link in typing.

It should have stated:

DIFFERNCE BETWEEN ACCOUNTING AND FINANCIAL OPERATING CASH FLOW.
The only main difference between the accounting and financial
operating cash flow  is that the interest is not considered to be an
outflow of cash according to financial definition.