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What is 'Cash Flow From Operating Activities (CFO)'

Cash flow from operating activities (CFO) is an accounting item that indicates the amount of money a company brings in from ongoing, regular business activities, such as manufacturing and selling goods or providing a service. Cash flow from operating activities does not include long-term capital or investment costs.

CFO can be calculated as follows:

Cash Flow From Operating Activities = EBIT + Depreciation - Taxes +/- Change in Working Capital

It is also known as operating cash flow (OCF) or net cash from operating activities.

BREAKING DOWN 'Cash Flow From Operating Activities (CFO)'

The cash flow statement of a company is divided into three sections - cash flow from operating, cash flow from investing, and cash flow from financing activities. All three sections provide a picture of where the company's cash is coming from, how it is spent, and the net change in cash resulting from the firm's activities. The cash flow from financing shows the source of a company's financing and capital, and its servicing and payments on the financing source. For example, proceeds from the issuance of stocks and bonds as well as dividend and interest payments will be included under financing activities. Cash flow from investing shows the cash used to purchase fixed and long-term assets, such as plant, property, and equipment (PPE), and also any proceeds from the sale of these assets.

The cash flow from operating activities constitutes the revenue-generating activities of a business. This section tells how much cash a company generated from its core business operations, and is reported on a company's quarterly and annual reports. There are two methods of calculating the cash flow from operations - the direct method and the indirect method.

The direct method assumes that all sales and purchases are made on credit. Under this method, various types of cash receipts and cash payments are calculated and added to obtain the net cash flow from operating activities. Items under the CFO include cash receipts from customers, cash payments to suppliers and vendors, salary payments to employees, interest payments, and income tax payments.

The indirect method is easier to compile and is used more frequently than the direct method. Using the indirect method, the net income figure from the income statement is used to calculate the net cash flow from operating activities. Since the income statement is prepared on an accrual basis, and there are a number of items on the income statement that affect net income but not cash flow, the earnings before interest and taxes (EBIT) must be adjusted for how much cash was actually generated by the business. To do this, noncash expenses, such as depreciation and amortization, are added back to net income. In addition, any changes to working capital, such as an increase and/or decrease in current assets and current liabilities are added to net income. Income that a company receives from investment activities is reported separately, since it is not from business operations. Similarly, cash flow from operating activities excludes dividends paid to stockholders and money spent to purchase long-term capital, such as equipment and facilities, because these are also one-time or infrequent expenses.

An increase in current assets such as accounts receivables or inventory will decrease cash flow from operations, and vice versa. An increase in current liabilities, such as accounts payable, will increase cash flow from operations since the longer it takes for a company to pay off its debt obligations, the more time it gets to keep and use the cash. Companies can therefore, influence the OCF by lengthening the time to pay off their debt, shortening the time to collect their dues from clients, and holding off on buying or restocking inventory.

Comparing cash flow from operating activities with EBITDA can give insights into how a company finances short-term capital. Also, investors will examine a company’s cash flow from operating activities separately from the other two components of cash flow - investing and financing activities - to determine where a company is really getting its money. Investors want to see positive cash flow because of positive income from recurring operating activities. Positive cash flow that results from the company selling off all its assets, or because it has recently issued new stocks or bonds, results in one-time gains and is not an indicator of long-term financial health. Investors will also examine the company’s balance sheet and income statement to get a fuller picture of company performance.

  1. Cash Flow Statement

    A cash flow statement is a financial statement that provides ...
  2. Direct Method

    The direct method is a method of creating the cash flow statement ...
  3. Business Activities

    Business activities are any activity that is engaged in for the ...
  4. Indirect Method

    The indirect method uses accrual accounting information to present ...
  5. Operating Activities

    Operating activities are those that pertain to a company's core ...
  6. Non-Operating Cash Flows

    Non-operating cash flows are inflows and outflows of cash that ...
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