Operating cash flow

Operating cash flow is the cash generated from a company's normal business operations. It starts with net income, adds back non-cash expenses (like depreciation and stock-based compensation), and adjusts for changes in working capital (like increases in accounts receivable or decreases in accounts payable).

OCF is reported on the cash flow statement and is the most important of its three sections (operating, investing, and financing). A company with positive OCF is generating cash from its business. A company with negative OCF is consuming cash to operate, regardless of what the income statement shows.

The gap between net income and OCF reveals important information about earnings quality. If a company reports strong net income but weak OCF, it may be recognising revenue before collecting cash (inflating receivables) or delaying expenses (building up payables). Persistent divergence between net income and OCF is a red flag that warrants investigation.

There are two methods for calculating OCF:

Both methods produce the same result. The indirect method starts from the income statement and adjusts to cash; the direct method tracks actual cash movements. Most companies use the indirect method because the data is more readily available.

For SaaS companies, the deferred revenue line is often the most important working capital item. When customers pay annual subscriptions upfront, cash arrives immediately but revenue is recognised over 12 months. This creates positive working capital effects that boost OCF above net income. Fast-growing SaaS companies with increasing annual prepayment rates often have OCF significantly higher than net income.

OCF margin (operating cash flow divided by revenue) is the most useful benchmark. For SaaS companies at scale, OCF margins of 20-35% are considered healthy. Growth-stage companies may have negative OCF margins as they invest in customer acquisition.

The OCF-to-net-income ratio is also informative. A ratio above 1.0 means the company generates more cash than it reports in profit, which is typical for businesses with strong deferred revenue or low capex. A ratio consistently below 1.0 warrants scrutiny of earnings quality.

1. 1

   Increase profitability

   Higher net income flows directly to OCF. Improve margins through pricing, cost control, and operating leverage.

2. 2

   Accelerate cash collection

   Reduce days sales outstanding (DSO) by invoicing promptly, offering early payment discounts, and automating collections.

3. 3

   Grow deferred revenue

   Encourage annual prepayment. Every customer who switches from monthly to annual billing creates an immediate OCF boost.

4. 4

   Manage payables strategically

   Use full payment terms available from suppliers. Paying on day 30 instead of day 10 keeps cash in the business 20 days longer.

1. 1

   Confusing OCF with free cash flow

   OCF does not deduct capital expenditures. A company with strong OCF but high capex may have weak or negative free cash flow.

2. 2

   Ignoring the quality of OCF

   OCF boosted by delaying payables or collecting receivables early is not sustainable. Look at the underlying drivers, not just the headline number.