Operating activities are the main revenue producing activities of a firm.  Operating cash flow (OCF) is the cash flow arising from day-to-day revenue and expense transactions due to the firm’s operating activities, which include cash received from customers and cash paid to suppliers and employees.  Operating cash flow shows the firm’s ability to repay loans, maintain its operating capability, pay dividends and to make new investments without recourse to external sources of financing.

Changes in a firm’s operating assets and operating liabilities during the accounting period cause cash flow from its revenue-producing activities to be different from its net income from operations.

The first key figure is net cash provided from operating activities.  This total includes the following items from the income statement:

  • Net earnings, showing the company’s profit (or loss); and
  • Depreciation and amortization expense.

Cash flow from operations also includes changes in some balance sheet items:

  • With the exception of the cash account, increases in current assets use cash and reductions provide cash; and
  • Increases in current liabilities provide cash and decreases use cash.

In arriving at net income in the income statement, depreciation and amortization are deducted as an expense.  However, depreciation and amortization are noncash expenses, which are expenses for which there is no payment of cash in the accounting period.  The depreciation and amortization expense incurred over the useful life of an asset does not represent a cash outflow, but rather recognizes the loss of economic usefulness of the asset.  The cost of long-term fixed assets, with the exception of land, is allocated over the assets’ useful life, rather than being expensed in the year of purchase.  Therefore, depreciation and amortization expenses are added back to net income and represent sources of cash.

Cash Flows from Operating Activities – Current Assets (Example)
Current Assets Balance Sheet
Increase		 Cash Flow
Change
Accounts Receivable 96,400 (96,400)
Inventory 24,341 (24,341)
Accumulated Depreciation 122,792 122,792

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