The amount of cash a company generates from its operating activities
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Cash flow from operations is the section of a company’s cash flow statement that represents the amount of cash a company generates (or consumes) from carrying out its operating activities over a period of time. Operating activities include generating revenue, paying expenses, and funding working capital. It is calculated by taking a company’s (1) net income, (2) adjusting for non-cash items, and (3) accounting for changes in working capital.
Cash Flow from Operations Formula
While the exact formula will be different for every company (depending on the items they have on their income statement and balance sheet), there is a generic cash flow from operations formula that can be used:
Cash Flow from Operations = Net Income + Non-Cash Items + Changes in Working Capital
Below is an example of Amazon’s operating cash flow from 2015 to 2017. As you can see in the screenshot below, the statement starts with net income, then adds back any non-cash items, and accounts for changes in working capital.
Follow these three steps:
Take net income from the income statement
Add back non-cash expenses
Adjust for changes in working capital
Cash Flow from Operations vs Net Income
Operating cash flow is calculated by starting with net income, which comes from the bottom of the income statement. Since the income statement uses accrual-based accounting, it includes expenses that may not have actually been paid for yet. Thus, net income has to be adjusted by adding back all non-cash expenses like depreciation, stock-based compensation, and others.
Once net income is adjusted for all non-cash expenses it must also be adjusted for changes in working capital balances. Since accountants recognize revenue based on when a product or service is delivered (and not when it’s actually paid), some of the revenue may be unpaid and thus will create an accounts receivable balance. The same is true for expenses that have been accrued on the income statement, but not actually paid.
Step 1: Start calculating operating cash flow by taking net income from the income statement.
Step 2: Add back all non-cash items. In this case, depreciation and amortization is the only item.
Step 3: Adjust for changes in working capital. In this case, there is only one line because the model has a separate section below that calculates the changes in accounts receivable, inventory, and accounts payable.
Cash Flow from Operations vs EBITDA
Earnings Before Interest Taxes Depreciation and Amortization (EBITDA) is one of the most heavily quoted metrics in finance. Financial Analysts regularly use it when comparing companies using the ubiquitous EV/EBITDA ratio. Since EBITDA doesn’t include depreciation expense, it’s sometimes considered a proxy for cash flow.
Since EBITDA excludes interest and taxes, it can be very different from operating cash flow. Additionally, the impact of changes in working capital and other non-cash expenses can make it even more different.
Thank you for reading this guide to understanding what cash flow from operations is, how it’s calculated, and why it matters. To learn more and continue building your career as a credit analyst, these additional CFI resources will be helpful:
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