1. OCF (Operating Cash Flow):
Definition: Operating cash flow is the inflow of money as well as outflow of cash which a firm generates through its core business activities in a given period. Here, it tends to be purely a cash inflow or outflow generated from the company’s major business lines, that is, from selling products or services.
What It Measures: OCF provides a better view of the company’s ability to raise cash through normal business operations, and this is a critical means through which the business operates, such as paying bills, wages, and plowing back into the business.
Calculation:
OCF
=
Net Income
+
Non-Cash Expenses (e.g., Depreciation)
−
Changes in Working Capital (e.g., Receivables, Inventory, Payables)
OCF=Net Income+Non-Cash Expenses (e.g., Depreciation)−Changes in Working Capital (e.g., Receivables, Inventory, Payables)
Why It’s Important: Shows the actual cash generated from the operations; it’s important because, although the income statement mentions profits, if a business isn’t generating enough cash from the operations, then it is generating net income but still has problems with its liquidity.
2. Net Income:
Definition: Net Income-net profit, bottom line, or profit-that final figure of profit appearing on the income statement to the effect of general expense, taxes, interest, depreciation, and other non-operating items deducted from its source.
What It Measures: It is a measure of profit/net income a company accumulates over a period. Such amounts include cash and also accruals, i.e., non-cash components like depreciation, amortization, and unrealized gains and losses.
Calculation
Net Income
Revenue−Expenses (including taxes,interest,depreciation and more)
It simply means Net Income = Revenue − Expenses (Taxes, Interest, Depreciation, etc.)
Why It’s Important: Net Income represents overall profitability or financial performance through all the expenses incurred by a business within a period. Therefore, it enables investors and stakeholders to assess the actual value of the company from this aspect.
Key Differences:
-
Focus:
OCF is concerned only with cash received and generated from the operation of a business.
Net Income is the total profitability after all cost incurred for all the expenses or costs even if such expenses are not paid in cash in terms of the period.
-
Cash vs. Accrual:
The term ‘cash basis’ means that it represents cash inflows and outflows for any business concerned.
Net Income is an accrual basis because net revenues have been recognized without taking into account the time when cash was actually received to liquidate such revenues and net expenses incurred without recognizing the time when cash is actually paid out to liquidate such expenses.
-
Non-cash Items:
OCF adjusts for non-cash items such as depreciation and amortization.
Net Income would include all the non-cash items, which makes it look either higher or lower than OCF.
-
Importance to Different Stakeholders:
OCF is much more relevant to investors and analysts who wish to judge whether a company can generate cash enough to pay its bills and to re-invest in the business.
Net income is crucial for establishing comprehensive profitability along with determining earnings per share, which remains one of the key performance drivers for shareholders.
Example:
Let’s apply the following to a pretend company.
Net Income: $1,000,000
Depreciation (non-cash): $100,000
Increase in Accounts Receivable (outflow): $50,000
Increase in Accounts Payable (inflow):$20,000
Then OC would be calculated as
OCF=Net Income + Depreciation -Increase in Accounts Receivable+Increase in Accounts Payable
=\1,000,000+\100,000-50,000+\20,000=1,070,000
End.
Conclusion:
Net income puts together cash and noncash items in order to arrive at an overall profit determination, which may or may not portray the true cash position of a firm.
The OCF is more effective at measuring a company’s cash-generating ability from its core activities and does directly measure liquidity.
Both the ratios are vital in the evaluation of the financial health of the company, though they provide different understandings of the performance.