How to Calculate Direct Operating Cash Flow
Operating cash flow is the amount of cash your business generates through regular operating activities within a specific period of time. If you calculate operating cash flow via the direct method, you’ll find that it directly reflects the inflows and outflows of your bank account. The direct method involves this equation:
Operating Cash Flow=Total Collected Cash from Customers - Cost of Goods Sold - Total Purchases - Operating Expenses.
Here are the five steps you need to take to calculate the direct operating cash flow:
- Accrual vs. Cash Revenue - If you manage your accounting on an accrual basis, you recognize revenue when you earn it, rather than receive it. Cash revenue, however, considers revenue when the money changes hands. To calculate your direct operating cash flow, you’ll need to identify your cash-basis revenue. Fortunately, many platforms like QuickBooks Online and Xero provide this information. Alternatively, simply take a look at all the money you received from your customers in that specific time frame.
- Non-Inventory Based Cost of Goods Sold - Next, look at your cost of goods sold or how much you spend to produce the goods or services you sell. This figure should exclude inventory and include lenders that require immediate payouts. These immediate payouts may be for wages, equipment costs, and freight.
- Inventory - Now, determine the money spent on your inventory, or the assets your business has and intends to sell to customers. It will likely include a mix of raw materials, work-in-progress items, and finished goods.
- Operating Expenses - Then, figure out your operating expenses. This will include things like wages, rent & utilities, software, sales & marketing, etc.
- Operating Cash Flow - Last but not least, take your cash revenue and subtract your cost of goods sold, purchases, and operating expenses. If you purchase recurring services with a credit card, be sure to deduct your credit card payments as well, so long as they’re not the same expenses noted in bullet #4.
Frequently Asked Questions
What is direct operating cash flow?
Direct operating cash flow measures the cash your business generates from its core operations during a specific period, based strictly on cash inflows and outflows.
Why is operating cash flow important?
Operating cash flow shows how well your business generates cash from everyday activities, helping you assess financial health, liquidity, and operational performance.
What is the difference between accrual and cash revenue?
Accrual revenue is recorded when earned, while cash revenue is recorded when payment is received. The direct method relies on cash revenue to accurately measure actual cash movement.
What expenses should be included in operating expenses?
Operating expenses include wages, rent, utilities, software, marketing, professional services, and other recurring costs necessary to run daily operations.
Which accounting platforms help track direct operating cash flow?
Platforms like QuickBooks Online and Xero make it easy to track cash-based revenue and expenses needed for accurate operating cash flow calculations.
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