Operating Cash Flow from Trading

Operating Cash Flow Definition

Operating cash flow or cash flow from operating activities, is that part of the cash flow generated by the trading activities of the business. It is basically the net income of the business adjusted for movements in working capital (inventory, accounts receivable, and accounts payable). It represents cash in from selling goods and services less cash out from paying the costs of selling goods and services.

If we look at the basic cash flow statement below, the highlighted elements represent the main components of Operating Cash Flow of the business.

Cash Flow Statement Highlighting Operating Cash Flow
Net income 10,000
Add back depreciation 12,000
Working capital -5,000
Operating activities 17,000
Capital expenditure -30,000
Investing activities -30,000
Debt repayments -10,000
New debt 26,000
New capital 12,000
Financing activities 28,000
Net cash flow 15,000
Opening cash balance 1,000
Closing cash balance 16,000

Net Income

Net income represents the profit of the business shown in the income statement.

Depreciation

Net income includes a deduction for depreciation, as we are looking at cash flow we want to exclude non cash elements of the income. Depreciation and amortization are added back as they are accounting entries to reflect the change in value of long term assets and do not involve the movement of cash.

Working Capital

The purpose of the working capital adjustment is to adjust the net income taken from the income statement of the business from an accruals basis to a cash basis.

The term working capital refers to the net liquid assets of a business used in it’s normal day to day trading operations. In a simple business it would be calculated as Inventory + Accounts receivable – Accounts payable representing the funding needed to buy inventory and provide credit to customers reduced by the amount of credit obtained from suppliers.

As each element of working capital changes the cash flow changes in the following ways:

Inventory

  • Inventory decreases – Cash inflow
  • Inventory increases – Cash outflow

Accounts Receivable

  • Account receivable decreases – Cash inflow
  • Accounts receivable increases – Cash outflow

Accounts payable

  • Accounts payable increases – Cash inflow
  • Account payable decreases – Cash outflow

In the above example, the cash flow from net income is 10,000 plus depreciation added back of 12,000, less the cash flow out of the business to fund working capital of 5,000. This results in a net operating cash flow or cash flow from operating activities of 17,000 into the business.

Examples of Operating Cash Flow

Examples of cash flow from operating activities include the following:

Operating Cash Inflow

  • Cash receipts from the sale of goods and services.
  • Cash receipts from royalties, fees, commissions and other revenue.
  • Cash receipts from investments, loans and other contracts held for trading purposes.
  • Collection of notes receivable.
  • Collection of interest income or dividends.
  • Cash refunds of income tax, unless identified with financing and investing activities.

Operating Cash Outflow

  • Cash payments to suppliers for goods and services.
  • Cash payments to employees.
  • Cash payments of income tax, unless identified with financing and investing activities.
  • Cash payments for investments, loans and other contracts held for trading purposes.
  • Interest payments.
Operating Cash Flow from Trading November 6th, 2016Team

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