Cash Flow from Operating Activities (CFO)

Updated June 22, 2021

What Is Cash Flow from Operating Activities?

Cash flow from operating activities (CFO) measures the cash-generating abilities of a company's core operations (instead of its ability to raise capital or buy assets). 

More simply, cash flow from operations is the money a company earns from its day-to-day business operations, whether from selling goods or providing services.

Cash flow from operating activities may also be referred to as operating cash flow (OCF) or net cash provided from operating activities.
 

Where to Find Cash Flows from Operating Activities 

Cash flows from operations can be found in the first section of a cash flow statement, which breaks down a company's cash inflow and outflow into three categories: 

  • Cash flows from operations 

  • Cash flows from investing activities, and 

  • Cash flows from financing activities.

How to Calculate Cash Flow from Operating Activities

There are two methods to calculate cash flow (via a cash flow statement): 

  1. Indirect 

Starting with the net income, work backward and apply adjustments for elements like depreciation and amortization (ie. non-cash items). 

  1. Direct 

This method refers to a company’s income statement to track all cash-based transactions (e.g. cash inflow, outflow) in order to find the cash flow from activities.

 

Indirect vs. Direct Cash Flow from Operating Activities

The indirect method converts income into cash flow and accounts for non-cash adjustments. The direct method, however, only takes cash transactions into account. Other differences include:

IndirectDirect
Net income is converted for cash flowReconciliation is done to convert the cash flow
All factors are accounted for with adjustments including depreciation and amortizationNon-cash factors are ignored
Adjustments can yield a less accurate statementNo adjustments are needed, making this a more accurate calculation method

Cash Flow from Operating Activities Formula

Over 98% of public companies use the indirect method, as the direct method is often too complicated. This is due to the requirement to classify potentially millions of transactions as either operating, investing, or financing – an incredibly costly and time-consuming process.

Cash flow from operating activities formula

Non-cash expenses are usually considered depreciation and/or amortization expenses. Changes to working capital include an increase and/or decrease in a company's current assets or liabilities.

Why a Cash Flow Statement Is Important

Cash flow statements are essential for companies to analyze their ability to pay for goods, salaries, services, and debt. Obviously, any company needs cash to survive and (hopefully) thrive. 

For investors, cash flow statements provide key insights for smart investing decisions. Since cash flow is a significant part of valuation models, it helps assess a company’s past and present business activities with a forecast for the future (e.g. discounted cash flow).

Cash flow measures are heavily influenced by a company’s cash from operations which, in turn, is heavily influenced by a company’s net income. This means that high revenue and low overhead are major drivers of cash flow from operating activities. Investors hunt for companies that have high (or improving) cash flow from operations but also have low share prices. The disparity often means that share prices will soon increase.

Related: 10 Things to Know about Every Cash Flow Statement 

Tips for Examining the Cash Flow of Operating Activities 

Investors should be aware that companies can influence cash flow from operating activities by: 

  • Lengthening the time they take to pay the bills (thus preserving their cash)

  • Shortening the time it takes to collect what’s owed to them (thus accelerating the receipt of cash)

  • Delaying inventory purchases (again preserving cash).

Keep this in mind when comparing the cash flow of different companies. It’s important to review multiple financial statements to more accurately examine a company’s financial health. 

What Does Negative Cash Flow Mean?

Investors should also note that having negative cash flow for a period of time isn’t always a bad thing. For example, a company introducing a new product may experience a dip in cash flow. If the company's new product (categorized under “operations”) generates more cash in the future, this could pay off. If the company has a negative cash flow from operations because it made poor decisions, then the long-term benefit simply won’t materialize. 

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Mark Herman has been helping friends with financial questions since serving as an Army helicopter pilot. Since then, he’s gained valuable experience in the corporate world before moving on to become a Certified Financial Planner™.

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