Operating Cash Flow: Computing Cash From Running the Business

Operating cash flow is the cash a business generated from running itself. By the indirect method it is computed as profit before tax, plus non-cash charges such as depreciation and the provision movement, plus finance cost where that is reported in financing, adjusted for the movement in working capital, less the tax actually paid. The tax figure is the amount actually paid, never the charge.

Profit before tax and operating cash flow describe the same twelve months of the same business, and the two differ for only three reasons. Some amounts were charged against profit while no cash moved. Some cash really did move but belongs on a different part of the statement. And some cash arrived or left in a different period from the sale or the cost it belongs to. The indirect methodA way of presenting the first section of a cash flow statement that starts from a reported profit figure and adjusts it, rather than listing receipts and payments one by one. removes those three groups from the profit figure, one group at a time, in a fixed order, so anybody holding the same accounts can check every step against a printed line.

What does operating cash flow measure?

Operating cash flow measures the cash the trading produced during the year, after the year’s own running bills were settled and before anything was spent on assets or paid to funders. Take a household. In one month a person might draw a salary, buy a second hand scooter and repay part of a loan. Only the first says whether the month paid for itself, so a person asked how the month went would not add the three together. Operating cash flow is that first group, computed for a business over a year.

The operating section prints three subtotals on its way down, and only the last of the three is operating cash flow. All three are real amounts and all three get quoted by people who mean the last one. Quoting either of the first two by mistake hands over a correctly computed, correctly labelled amount, roughly Rs 6,00,000 or Rs 23,00,000 away from the figure asked for.

What is the starting point, and where is it found?

The starting point is profit before tax, printed on the face of the statement of profit and loss as the subtotal immediately above the tax line. The figure is copied, never computed or rebuilt. Captions vary, so profit before tax and earnings before tax name the same subtotal in the same position. Where exceptional items sit between the subtotal and the tax line, the figure to take is the one the tax charge was actually deducted from.

The computation starts at profit before tax rather than profit after tax because the tax is put back later as a cash payment, not as a charge, and starting one line too low counts it twice. The size of the error is exact. Beginning at Anjani Stationers’ profit after tax of Rs 30,00,000, applying the same adjustments and taking off the Rs 6,20,000 of tax paid lands on Rs 28,30,000. Rs 28,30,000 is short by Rs 8,00,000, the whole charge, deducted once by the statement of profit and loss and again by the computation.

Which non-cash charges are added back, and where are they found?

Three amounts are added back, and each is a printed line or a printed movement rather than an estimate. Depreciation and amortisationThe spreading of the cost of a long lived asset over the years it is used. Amortisation is the word used where the asset has no physical form, such as software. of Rs 12,00,000, one line on the face. The movement in the provision for doubtful debtsAn amount set aside against customer balances the business does not expect to collect in full, shown as a deduction from those balances. of Rs 6,00,000, found in the receivables note as closing Rs 9,00,000 less opening Rs 3,00,000. And the finance cost of Rs 3,50,000, printed between operating profit and profit before tax.

Every add-back is a number that can be pointed to in the accounts, so anybody holding the same statements can check the Rs 59,50,000 subtotal. Two of the three are added back because no cash left the business when they were charged. The finance cost is there for a different reason: the same Rs 3,50,000 is reported lower down as interest paid, so leaving it inside the operating figure would take one payment out of the year twice.

One movement looks like it belongs here and does not. A right-of-use assetThe asset a business records when it takes something on a long lease, standing for its right to use that item for the lease term, with a matching liability for the payments owed. of Rs 7,00,000 was recognised with a matching lease liability of Rs 7,00,000. No cash moved, so it appears nowhere in this computation and is disclosed separately as a non-cash transaction. There is no line to find. The absence is the correct outcome rather than a missing one.

Which working capital movements are applied, and where are they found?

The movements are found by putting the two balance sheets side by side and reading the difference on each working capitalThe short term balances a business carries while trading: what customers owe it, what it holds in stock, and what it owes suppliers and customers who have paid ahead. line. Four moved: trade receivables, inventories, trade payablesAmounts a business owes its suppliers for goods and services already received but not yet paid for. and the contract liabilityMoney a customer has already paid for goods or services the business has not yet delivered, carried as a liability until it does.. Nothing is estimated: one printed balance is subtracted from another, four times.

An asset rising is an outflow and a liability rising is an inflow, and that one sentence fixes the sign of every line here. The reason behind the rule is what makes it stick. If what customers owe the business rises, the sales were made and the money has not arrived, so cash went into that balance. If what the business owes its suppliers rises, the goods were taken and not paid for, so the cash stayed in the business. A stationery supplier letting a school pay a term late has the first; the same supplier taking ninety days from its paper mill has the second.

The four lines appear below with both balances. The published year one sheet gave a total rather than a split, so the year one balances other than cash and gross receivables are assumed. The receivables line is taken gross, before the provision: the Rs 6,00,000 provision movement has already been added back as a non-cash charge, so applying the net movement of Rs 11,00,000 here as well would remove the same Rs 6,00,000 twice. Rs 11,00,000 plus Rs 6,00,000 is Rs 17,00,000, and that check is worth running every time.

One thing in that table makes year two unusually easy to reason about. The inventory outflow of Rs 9,00,000, the payables inflow of Rs 7,00,000 and the contract liability inflow of Rs 2,00,000 net to exactly nil. The whole Rs 17,00,000 movement is carried by the receivables line on its own. The netting holds for this year rather than in general, and it lets the simulation below move one line and show the entire working capital effect.

Which tax figure is deducted, and where is it found?

Three tax amounts sit in a set of accounts, they sound almost identical, and only one belongs on this line. The total tax expense of Rs 8,00,000, printed on the face. The current tax of Rs 6,20,000, printed in the note behind that line where the charge splits into current and deferred taxA charge or credit that arises because the accounts and the tax computation take the same item into different periods, so it is recorded now and settled later.. And tax paid, the amount actually remitted, reported on this very line. Here the current tax and the amount remitted are both Rs 6,20,000; in a real set of books they often differ and the remitted amount is the one to take.

The line is captioned tax paid because it reports a payment, so the figure that belongs on it is Rs 6,20,000 and never the Rs 8,00,000 charge, and the Rs 1,80,000 between them is deferred tax charged against profit without being paid. Deducting Rs 6,20,000 from Rs 42,50,000 gives Rs 36,30,000. Deducting Rs 8,00,000 gives Rs 34,50,000, an amount that looks reasonable and will not reconcile with anything. The failure block below walks that version to where it breaks.

What does Anjani Stationers' calculation give?

Here is the whole computation: eight inputs, three subtotals, one answer. Read the middle column as an instruction rather than an explanation. Every amount is held in whole rupees at each step.

The rest of the statement has to carry the finished figure down to a cash balance somebody else already published, so the figure is checkable in a way no single ratio ever is. Rs 36,30,000 from operating, less Rs 34,00,000 used in investing and Rs 4,30,000 used in financing, is a fall of Rs 2,00,000. Opening cash was Rs 7,00,000, so closing cash is Rs 5,00,000. The year two balance sheet prints exactly Rs 5,00,000. The tie to closing cash is worth running on every operating cash flow computed: a figure that is out is out by a findable amount, and the size of the gap usually names the input that caused it.

Five settings of the receivables cell give the following readings. At the reported minus Rs 17,00,000 the operating figure is Rs 36,30,000 and closing cash is Rs 5,00,000. The statement ties. At minus Rs 20,00,000 it is Rs 33,30,000 and closing cash Rs 2,00,000. At minus Rs 30,00,000 it is Rs 23,30,000 and closing cash minus Rs 8,00,000, an overdraft rather than a balance. At minus Rs 5,00,000 it is Rs 48,30,000 and closing cash Rs 17,00,000. At plus Rs 10,00,000, meaning receivables fell, it is Rs 63,30,000 and closing cash Rs 32,00,000. In every reading the distance from the published Rs 5,00,000 is exactly the distance from the reported movement, rupee for rupee. The exact correspondence is what makes the tie a usable check on the keying.

What does each reader do with the finished figure?

Rs 36,30,000 is computed by somebody who then has to act, and different people take it somewhere different. A lender sizing a working facility reads it against what the year owes: Rs 3,50,000 of interest and Rs 1,00,000 of lease repayment. An analyst reads it beside the profit that produced it and against the prior year. Anjani Kulkarni, deciding what she can draw, reads it against the Rs 34,00,000 committed to equipment and to Chitra Binding. The figure had to cover that commitment before anything reached her.

The finished figure is a routing instruction as much as a result: the size of the working capital line inside it tells the reader which document to open next. Where the movement is small, the operating figure sits close to the subtotal above it and the reader stays with the statement of profit and loss. Where it is large, as here at Rs 17,00,000 against Rs 59,50,000, the missing cash is sitting in the balance sheet and the receivables note, and those are the next things to open.

Anjani Stationers Private Limited, Chitra Binding Works Private Limited, Anjani Kulkarni, Meera Rao and the Sunrise Public School group are invented.
Educational material. Not advice on any investment, tax, budget or market position.