Introduction
Operating cash flow and net Income are two different metrics providing a glimpse into the health of a company’s financial system. Let us understand these to analyze the company’s financial performance. While one helps indicate the cash generated by a company from its core business activities, the other focuses on profitability from a net income perspective after deducting all expenses, which could also include non-cash items. This comparison will guide an investor or manager in deciding on liquidity and profitability.
Operating Cash Flow
Operating cash flow refers to the cash generated by a specific business operation. This facilitates the identification of whether the firm is generating enough positive cash to sustain and grow business operations using only its internally generated funds, thus avoiding funding from external sources. There are three types of cash flows exhibited in a company’s statement of cash flows: operating, investing, and financing.
Operating cash flows account for all inflows and outflows undertaken by a company in its major business activities like selling, purchasing inventory, providing services, and paying salaries and wages. This does not consider the investing and financing activities of the company , such as borrowing, buying capital equipment, and paying dividends .
Formula
While each company’s actual formula will be different-applying what appears on a company’s actual income statement and balance sheet-there’s a general formula for cash flow from operations:
Cash Flow from Operations = Net Income + Non-Cash Items + Changes in Working Capital
Net Income
Net income is an accounting measure indicating the amount by which income exceeds total expenses for the same period. If revenue is lower than total expenses, then the company has realized a net loss. Net income is calculated by subtracting total expenses from total revenues. It is most commonly referred to as “the bottom line.” Public companies always report their net income on quarterly and annual income statements.
Another important figure for investors regarding how much revenue exceeds the expenses of an organization is net income , often referred to as net earnings.
Net income = Sales – Cost of Goods Sold – Selling, General, and Administrative Expenses – Operating Expenses + Depreciation – Interest + Taxes + Other Expenses.
It would appear in the income statement of the company and is considered a profitability indicator of the organization . Net income can also be understood as an individual’s income after paying taxes and having other deductions, such as those given to NGOs and savings for retirement.
Operating cash flow vs. Net income
Conclusion
Operating Cash Flow (OCF) and Net Income play different roles in financial analysis. OCF portrays cash flow from operations, which is crucial when estimating liquidity. Net income indicates whether the company is profitable. Collectively, these measures provide a complete view of the firm’s present financial health, enabling stakeholders to assess whether the firm is capable of making a profit and being sound in the future.