How to Calculate Operating Cash Flow

In investing, "operating cash flow" refers to the amount of cash a company generates from its operations. Here's how to calculate it.

Things You'll Need

• Company annual report

Instructions

1. Operating cash flow is calculated by a relatively simple equation:EBIT (earnings before interest and taxes)+ Depreciation- Taxes.EBIT is also known as operating income. This information can be found in a company's annual report.

2. For this example, we'll use Microsoft's 2007 annual report. The company reported EBIT (operating income) of $18,524, depreciation of $1,440, and taxes of $6,036 (numbers in millions). So the math looks like this:$18,524+ $1,440- $6,036= $13,928. In other words, Microsoft's operating cash flow for 2007 was $13,928.

3. Operating cash flow is a solid measure of a company's profits because it refers to actual cash made from operations and is thus hard to manipulate. A company could be bringing in tons of money but still be struggling to pay its bills. Its healthy operating cash flow proves this is not the case for Microsoft.

4. Looking at operating cash flow will show you whether a company is burning more money than it is earning. If you don't want to (or don't have time to) check every detail of a company's finances, operating cash flow is a good at-a-glance snapshot of how the business is doing. Positive cash flow is a good sign, while negative cash flow needs to have a one-time explanation (an investment or expense that will not be repeated; for example, an acquisition or a new factory). If a company's cash flow has been negative for years, or if its cash flow is steadily decreasing, this is a warning sign that means you may want to dig deeper before making any type of investment in the company.

5. In recent years, cash flow has gained in popularity as a financial measure because it is more difficult to manipulate than certain other metrics, such as revenues. A company could make its revenues look bigger by, for example, postponing rebates (which would lower revenues) until the next reporting period, thus creating the appearance of a business that's more prosperous than it really is. However, because operating cash flow deals with actual money, it's much harder for a company to "massage the numbers" into saying what management wants them to say. This is why it's such a key financial metric, despite its seeming simplicity.

Resources

• Read this Article in Spanish
• EDGAR, the Securities and Exchange Commission's database of company filings.