Cash flow from operations, also called operating cash flow, refers to the difference between cash received from operating sources and cash disbursed for inventory and operating expenses.
Cash flow from operations is one of three sections on a firm’s cash flow statement. The other two sections are cash flow from financing activities and cash flow from investing activities.
Operating cash flow is the most important financial consideration for a firm. Operating cash flow is the source from which the company invests in growth, maintains operating capacity, and provides returns to its capital providers. A firm which cannot generate long-term operating cash flow is likely to fail as an ongoing business.
In the short-term, a firm which produces negative operating cash flow can finance its deficit with either existing cash balances or by raising external capital in the form of debt or equity. However, a firm will be unable to obtain external financing unless equity investors or creditors believe that the cash flow deficit is temporary. Temporary cash flow deficits are common among fast-growing firms and firms which are going through a corporate restructuring.
There are two methods for calculating operating cash flow: the direct method and the indirect method. Under the direct method, operating cash flow is calculated on a line-by-line basis. Thus, the firm will start with cash received from customers and subtract cash paid to suppliers, cash paid to employees, cash paid for interest, cash paid for taxes, etc. In contrast, under the indirect method, the firm reconciles net income to operating cash flow by adding or subtracting from net income changes in working capital accounts.
