Cash Flow from Operations

What is Cash Flow from Operations?

Cash flow from operations is the section of a company’s cash flow statementCash Flow Statement​A Cash Flow Statement (officially called the Statement of Cash Flows) contains information on how much cash a company has generated and used during a given period. It contains 3 sections: cash from operations, cash from investing and cash from financing. 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 revenueRevenueRevenue is the value of all sales of goods and services recognized by a company in a period. Revenue (also referred to as Sales or Income) forms the beginning of a company’s Income Statement and is often considered the “Top Line” of a business., paying expenses, and funding working capital. It is calculated by taking a company’s (1) net incomeNet IncomeNet Income is a key line item, not only in the income statement, but in all three core financial statements. While it is arrived at through the income statement, the net profit is also used in both the balance sheet and the cash flow statement., (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 + Increase in Working Capital

Learn more with detailed examples in CFI’s Financial Analysis Course.

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 capitalNet Working CapitalNet Working Capital (NWC) is the difference between a company's current assets (net of cash) and current liabilities (net of debt) on its balance sheet. It is a measure of a company’s liquidity and its ability to meet short-term obligations as well as fund operations of the business. The ideal position is to.

Follow these three steps:

1. Take net income from the income statement
2. Add back non-cash expenses
3. Adjust for changes in working capital

Cash Flow from Operations vs Net Income

Operating cash flowOperating Cash FlowOperating Cash Flow (OCF) is the amount of cash generated by the regular operating activities of a business in a specific time period. The operating cash flow formula is net income (form the bottom of the income statement), plus any non-cash items, plus adjustments for changes in working capital is calculated by starting with net income, which comes from the bottom of the income statement. Since the income statement uses accrual-based accountingAccrual PrincipleThe accrual principle is an accounting concept that requires transactions to be recorded in the time period during which they occur, regardless of the time period when the actual cash flows from the transaction are received. The idea behind the accrual principle is that financial events involve matching revenues, 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 expense 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 revenueRevenue RecognitionRevenue recognition is an accounting principle that outlines the specific conditions under which revenue is recognized. In theory, there is a wide range of potential points at which revenue can be recognized. This guide addresses recognition principles for both IFRS and U.S. GAAP. 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 receivableAccounts ReceivableAccounts Receivable (AR) represents the credit sales of a business, which are not yet fully paid by its customers, a current asset on the balance sheet. Companies allow their clients to pay at a reasonable, extended period of time, provided that the terms are agreed upon. 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 statementIncome StatementThe Income Statement is one of a company's core financial statements that shows their profit and loss over a period of time. The profit or loss is determined by taking all revenues and subtracting all expenses from both operating and non-operating activities.This statement is one of three statements used in both corporate finance (including financial modeling) and accounting..

Step 2: Add back all non-cash items. In this case, depreciationDepreciation ExpenseDepreciation expense is used to reduce the value of plant, property, and equipment to match its use, and wear and tear, over time. Depreciation expense is used to better reflect the expense and value of a long-term asset as it relates to the revenue it generates. 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, inventoryInventoryInventory is a current asset account found on the balance sheet, consisting of all raw materials, work-in-progress, and finished goods that a company has accumulated. It is often deemed the most illiquid of all current assets - thus, it is excluded from the numerator in the quick ratio calculation., and accounts payable.

Cash Flow from Operations vs EBITDA

Earnings Before Interest Taxes Depreciation and Amortization (EBITDAEBITDAEBITDA or Earnings Before Interest, Tax, Depreciation, Amortization is a company's profits before any of these net deductions are made. EBITDA focuses on the operating decisions of a business because it looks at the business’ profitability from core operations before the impact of capital structure. Formula, examples) is one of the most heavily quoted metrics in finance. Financial AnalystsFMVA® CertificationThe Financial Modeling & Valuation Analyst (FMVA)® accreditation is a global standard for financial analysts that covers finance, accounting, financial modeling, valuation, budgeting, forecasting, presentations, and strategy. regularly use it when comparing companies using the ubiquitous EV/EBITDAEV/EBITDAEV/EBITDA is used in valuation to compare the value of similar businesses by evaluating their Enterprise Value (EV) to EBITDA multiple relative to an average. In this guide, we will break down the EV/EBTIDA multiple into its various components, and walk you through how to calculate it step by step 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 expensesNon Cash ExpensesNon cash expenses appear on an income statement because accounting principles require them to be recorded despite not actually being paid for with cash.  The most common example of a non cash expense is depreciation, where the cost of an asset is spread out over time can make it even more different.

Learn more in CFI’s Business Modeling Courses.

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 expendituresCapital ExpendituresCapital expenditures refer to funds that are used by a company for the purchase, improvement, or maintenance of long-term assets to improve the efficiency or capacity of the company. Long-term assets are usually physical and have a useful life of more than one accounting period. (CapEx), which can be found under Cash Flow from Investing ActivitiesCash Flow from Investing ActivitiesCash Flow from Investing Activities is the section of a company's cash flow statement that displays how much money has been used in (or generated from) making investments during a specific time period. Investing activities include purchases of long-term assets, acquisitions of businesses, and investments in marketable securities.

Deducting capital expenditures from cash flow from operations gives us Free Cash FlowFree Cash Flow (FCF)Free Cash Flow (FCF) measures a company’s ability to produce what investors care most about: cash that's available be distributed in a discretionary way, which is often used to value a business in a discounted cash flow (DCF) modelDCF Model Training Free GuideA DCF model is a specific type of financial model used to value a business.  DCF stands for Discounted Cash Flow, so the model is simply a forecast of a company’s unlevered free cash flow discounted back to today’s value.  This free DCF model training guide will teach you the basics, step by step with examples and images.

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

Additional Resources

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 Financial AnalystFMVA® CertificationThe Financial Modeling & Valuation Analyst (FMVA)® accreditation is a global standard for financial analysts that covers finance, accounting, financial modeling, valuation, budgeting, forecasting, presentations, and strategy. , these additional CFI resources will be helpful:

• Capital ExpendituresCapital ExpendituresCapital expenditures refer to funds that are used by a company for the purchase, improvement, or maintenance of long-term assets to improve the efficiency or capacity of the company. Long-term assets are usually physical and have a useful life of more than one accounting period.
• Depreciation MethodsDepreciation MethodsThe most common types of depreciation methods include straight-line, double declining balance, units of production, and sum of years digits. There are various formulas for calculating depreciation of an asset. Depreciation expense is used in accounting to allocate the cost of a tangible asset over its useful life.
• Non Cash ExpensesNon Cash ExpensesNon cash expenses appear on an income statement because accounting principles require them to be recorded despite not actually being paid for with cash.  The most common example of a non cash expense is depreciation, where the cost of an asset is spread out over time
• Working Capital CycleWorking Capital CycleThe Working Capital Cycle for a business is the length of time it takes to convert the total net working capital (current assets less current liabilities) into cash. Businesses typically try to manage this cycle by selling inventory quickly, collecting revenue quickly, and paying bills slowly, to optimize cash flow.