Cash Flow from Operations

The amount of cash a company generates from its operating activities

What is Cash Flow from Operations?

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

Cash Flow from Operations Example

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.

1. Take net income from the income statement
3. 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.

Sample Calculation

Let’s look at a simple example together from CFI’s Financial Modeling Course.

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.

Capital Expenditures

While operating cash flow tells us how much cash a business generates from its operations, it does not take into account any capital investments that are required to sustain or grow the business.

To get a complete picture of a company’s financial position, it is important to take into account capital expenditures (CapEx), which can be found under Cash Flow from Investing Activities.

Deducting capital expenditures from cash flow from operations gives us Free Cash Flow, which is often used to value a business in a discounted cash flow (DCF) model.

Learn to build a DCF model in CFI’s Business Valuation Modeling Course!