Keeping a careful watch on cash flow is a vital component of maintaining your company's financial health for organisations of all sizes. Cash flow can be measured in a variety of ways. Simply comparing the balance of your business's bank account with the balance from one month ago will provide a basic cash flow measurement. However, there are more advanced methods of cash flow analysis, such as operational cash flow and free cash flow. What are the distinctions between these two measurements, though? With this thorough information, you can learn more about operating cash flow vs. free cash flow.
What is the definition of operating cash flow?
The capital that your business creates via its main business activities is referred to as operating cash flow, also known as cash flow from operating activities or cash flow produced by operations. Expenses, revenue from investments, and long-term capital expenditures are not included. To put it another way, the operating cash flow ratio is solely concerned with your regular business activities.
Operating cash flow is an important measure to grasp since it indicates whether your firm has enough capital to operate and develop. Businesses with positive operating cash flow, for example, can fund expansion, develop new goods and service lines, and distribute dividends to shareholders. With a negative operating cash flow ratio, this isn't conceivable.
How to Calculate an Operating Cash Flow
Because various firms don't always have the same items on their balance sheet, the formula that businesses use to calculate operating cash flow is likely to change. However, in general, the operating cash flow ratio can be calculated using the following formula:
Net income plus non-cash items plus changes in working capital equals operating cash flow.
What is the definition of free cash flow?
After capital expenditures, free cash flow refers to the money your organisation generates from its primary business activities (i.e. long-term fixed assets like equipment or real estate). In other words, free cash flow is the amount of cash left over after accounting for financial outflows that enable your organisation increase its assets and maintain continuous operations.
Free cash flow is a great instrument for determining not only how successfully your organisation can generate cash from routine business activities, but also how much capital expenditures affect your cash flow. Free cash flow is frequently used by investors and business analysts to determine whether your firm has enough cash to pay creditors, buy back shares, and pay dividends.
What is the formula for calculating free cash flow?
It's easy to learn how to calculate free cash flow because all you have to do is subtract the cost of long-term capital expenditures from an operational cash flow calculation. The following is a formula for this formula:
Operating Cash Flow – Capital Expenditures = Free Cash Flow
Is free cash flow the same as operating cash flow?
Let's look at operating cash flow vs. free cash flow now that you've learned a little more about these financial performance measurements. The main distinction between the two metrics is that free cash flow and operating cash flow are both measurements of different things. Unlike the operational cash flow ratio, which is exclusively concerned with the amount of cash created by your company's main operating activities, free cash flow examines how effectively cash is generated from those core operations.
An operating cash flow assessment, for example, may reveal that your company has a capital reserve derived from core operations. When looking at the company's free cash flow, however, cash outlays may disclose that the company has taken on a significant amount of debt and isn't in such a solid financial position. Both measures, when combined, should provide you with a thorough picture of your company's financial health.