Is your business not generating enough cash flow from operations to solve cash flow issues?
From my experience as a cash flow expert and CFO working with small business owners over the last twenty years across various sectors—such as retail, dental practices, marketing agencies, coaches and consultants, and e-commerce—operating cash flow issues are the primary source of stress and anxiety, leading to sleepless nights and plateaued business growth. In fact, according to score.org, 82% of small businesses fail due to them.
How to Identify Poor Operating Cash Flow?
Identify poor operating cash flow through these red flags:
- Your accounts receivable balance increases month after month, tying up cash in unpaid invoices, which causes businesses to struggle with covering operating expenses.
- You are over-relying on short-term financing to cover day-to-day operations.
- You are seeing reminders, supplier statements, and HMRC VAT, PAYE, and Self Assessment unpaid notices.
Download my free guide: 10 Steps to Manage, Mobilize, and Optimize Your Operating Cash Flow
In this actionable guide, you’ll gain an expert-level understanding of operating cash flow—how to calculate, improve, and forecast it effectively.
Whether you’re a product-based business dealing with optimizing inventory management or a service-led business managing delayed client payments, you will:
- Master operating cash flow calculations using both direct and indirect methods.
- Implement strategies to improve cash flow by accelerating accounts receivable, optimizing accounts payable, and managing inventory.
- Leverage technology tools like Xero and QuickBooks Online to automate invoicing, streamline collections, and monitor cash flow in real-time.
- Analyze real-world cash flow examples from both product-led and service-led businesses for actionable insights.
- Forecast operating cash flow with confidence using our exclusive calculator and template to plan for business growth and financial uncertainties.
Plus, access exclusive tools like our operating cash flow calculator and forecasting template to implement these strategies immediately.
Why Trust My Expertise On Operating Cash Flow?
I am Shishir Khadka, a Chartered Certified Accountant (FCCA) and CFO with over two decades of experience helping businesses grow from cash flow challenges to over £53.8 million in annual sales revenue.
Through my company, Hungry Cash Flow Ltd, I’ve worked with hundreds of businesses across industries, implementing strategies that transform their cash flow and drive sustainable growth.
My insights have been featured in The Independent, where I’ve shared expertise on cash flow management and business growth strategies. I’ve also partnered with leading platforms like Agicap, hosting webinars to help businesses leverage cutting-edge cash flow forecasting tools. I’ve contributed thought leadership articles to platforms such as Float App and delivered masterclasses for Zoho on cash flow management and optimization.
Key Takeaways
- Understand and Calculate OCF: Use direct and indirect methods to understand your business’s cash position clearly.
- Optimize Cash Flow: Apply strategies like dynamic discounting and leveraging AI-powered tools.
- Forecast Operating Cash Flow: Use tools like Agicap and QuickBooks Online to model future scenarios and plan for cash flow fluctuations.
- Protect Cash Flow During Downturns: Strengthen payment terms, renegotiate supplier agreements, and maintain cash reserves.
What Is Operating Cash Flow ?
Operating Cash Flow (OCF) refers to cash generated from a company’s core business operations. It doesn’t include cash generated from investing and financing cash flow. OCF is the main source of cash generation to maintain working capital, ensure financial stability, and fuel business growth.
Where Can You Find Operating Cash Flow?
You can find operating cash flow listed under the cash flow from operating activities section in the cash flow statement. Similarly, you will find investing cash flow under the cash flow from investing activities and financing cash flow under the cash flow from financing activities.
How Do You Calculate Operating Cash Flow?
There are two methods for calculating operating cash flow: the direct method and the indirect method. Both methods provide the same result, but they approach the calculation differently.
What’s the Formula for Calculating OCF Using the Direct Method?
The direct method calculates OCF by looking directly at cash inflows and outflows from operating activities, such as customer payments, supplier payments, and wages. The formula is:
Operating Cash Flow (Direct Method) = Cash Inflows – Cash Outflows
This method gives a clear picture of where cash is coming from and where it’s going, making it useful for businesses with simple, straightforward cash transactions, like retail stores or service-based businesses.
What’s the Formula for Calculating OCF Using the Indirect Method?
The indirect method starts with net income from your profit and loss statement , also referred as income statement and adjusts for non-cash transactions (like depreciation) and changes in working capital (such as accounts receivable, accounts payable, and inventory). The formula is:
Operating Cash Flow (Indirect Method) = Net Income + Non-Cash Adjustments – Changes in Working Capital
This method is commonly used by businesses that operate on accrual accounting, where revenue and expenses are recorded when they’re earned or incurred, not when the cash is actually received or paid.
What Is An Example of Operating Cash Flow
Here are examples of operating cash flow for both product-led and service-led businesses.
Product-Led Business Example
For a product-based business, such as a retail store selling clothes, electronics, handbags etc. operating cash flow include cash inflows from product sales and cash outflows for inventory purchases, rent, payroll and admin expenses.
The Business will experience cash flow issues, despite being profitable, if sales are strong but inventory levels are too high in proportion to working capital needs. This has been my experience of working with hundreds of retail and ecommerce clients over the years doing six, seven and eight figures business.
Service-Led Business Example
For a service-based business, like marketing agencies, dental practices OCF would focus on cash inflows from client payments and outflows for staff salaries, software tools, and operating expenses. Since payments from clients are often delayed, managing accounts receivable efficiently is key to maintaining healthy cash flow.
What Are the Key Ratios to Measure Operating Cash Flow?
The key ratios to measure operating cash flow include operating cash flow to sales ratio, operating cash flow coverage ratio for debt, and operating cash flow to current liabilities ratio.
Operating Cash Flow to Sales Ratio
The operating cash flow to sales ratio, also known as the operating cash flow ratio, shows how efficiently revenue is being converted into cash. It’s especially important for businesses with high inventory costs or delayed receivables.
Formula:
OCF to Sales Ratio = Operating Cash Flow ÷ Net Sales
Example: If your business generates £1 million in sales but only £100,000 in operating cash flow, your OCF to Sales Ratio is 10%, signaling room for cash flow optimization.
Operating Cash Flow to Current Liabilities Ratio
Operating Cash Flow To Current Liabilities ratio measures your business’s ability to cover short-term obligations with cash from operations. A higher ratio indicates strong liquidity, while a lower ratio suggests potential cash flow issues.
Formula:
OCF to Liabilities Ratio = Operating Cash Flow ÷ Current Liabilities
Example: With £200,000 in OCF and £150,000 in liabilities, your ratio of 1.33 indicates sufficient cash flow to cover immediate liabilities.
OCF Coverage Ratio for Debt
This ratio assesses your ability to cover debt interest payments using cash flow, which is crucial for lenders evaluating your credit risk.
Formula:
OCF Coverage Ratio = Operating Cash Flow ÷ Interest Payments
Example: With £300,000 in OCF and £50,000 in interest payments, a ratio of 6.0 suggests strong capacity to meet debt obligations.
How To Improve Operating Cash Flow?
To improve operating cash flow, in addition to traditional methods, here are a few unique strategies I’ve implemented to boost operating cash flow.
Dynamic Discounting for Early Payments
Rather than offering a fixed early payment discount, implement dynamic discounting, where the discount rate decreases the longer the customer takes to pay. This allows you to capture more value while still incentivizing early payments.
I implemented this strategy for a retail client selling pre-owned luxury furniture. It resulted in decreasing the accounts receivable balance by 17.25%, adding £39,259.35 cash to the bank balance.
Cash Flow Forecasting with AI Tools
Leverage AI cash flow forecasting tools to speed up operating cash flow forecasting. I have partnered with Agicap to help my clients increase speed and accuracy in predicting cash flow trends based on historical data and real-time inputs.
Subscription-Based Revenue Models
One of my clients provides dental treatment services to patients. He also helps other dental practices run digital subscription-based models with negligible operating costs. This strategy has provided him with recurring predictable cash flow, representing 17.25% of his total cash inflow in a specific period.
Use our free operating cash flow calculator to see how these strategies can transform your cash position today.
Before-and-After Case Study: Transforming Cash Flow
A consulting firm struggling with delayed client payments and rising accounts receivable balances came to us. After implementing our dynamic discounting strategy and optimizing their invoicing processes with automation tools like Xero, they reduced their outstanding receivables by 40% and saw a 30% improvement in cash flow within six months.
How Does Economic Downturn Impact Operating Cash Flow
During an economic downturn, businesses often face decreased sales, delayed customer payments, and increased pressure to meet operational expenses. Managing operating cash flow becomes even more critical to maintaining the health and survival of your business. Many businesses have gone into administration in the UK since Brexit and post-COVID-19, such as Made.com, L.K. Bennett, and Peacocks (Source: Wikipedia).
Most of these brands suffered due to:
- Declining Sales: Reduced consumer demand leads to fewer sales and lower cash inflows.
- Delayed Payments: Clients may delay payments, extending accounts receivable and squeezing your cash flow.
- Rising Costs: Operational expenses may remain high or even increase, creating a mismatch between inflows and outflows.
How Can You Protect Your Operating Cash Flow During a Downturn?
To protect your operating cash flow during tough times, focus on these strategies:
- Strengthen Payment Terms with Your Customers
- Renegotiate Supplier Terms and ensure the supplier value chain is reliable and cost-effective.
- Focus on Cash-Generating and High-Margin Activities
Expert Quotes from Other Chartered Accountants on Operating Cash Flow
Insights from two seasoned Chartered Accountants:
Overview of Investing Cash Flow and Financing Cash Flow
To understand your business’s cash flow health, it’s important to supplement your knowledge of Operating Cash Flow (OCF) with insights into Investing Cash Flow and Financing Cash Flow. These two elements complete the cash flow picture, showing how capital is managed beyond day-to-day operations.
What Is Investing Cash Flow?
Investing Cash Flow reflects cash used for investments in long-term assets or cash received from the sale of these assets. This section of the cash flow statement reveals how much your business is investing in growth or divesting from assets to maintain liquidity.
Examples of Investing Activities:
- Purchasing Assets: Investments in equipment, property, or technology.
- Proceeds from Asset Sales: Cash received from selling company assets.
- Investing in Securities: Buying or selling stocks, bonds, or other financial investments.
For a deeper dive into how investing cash flow impacts your business.
What Is Financing Cash Flow?
Financing Cash Flow relates to cash transactions between your business and its investors or creditors. It includes cash inflows from funding activities such as issuing shares or taking out loans, as well as cash outflows like repaying loans or paying dividends.
Examples of Financing Activities:
- Debt Transactions: Borrowing money through loans or repaying them.
- Equity Transactions: Issuing new shares or buying back stock.
- Dividend Payments: Cash outflows from distributing profits to shareholders.
Both Investing and Financing Cash Flows are crucial for understanding how capital is sourced and deployed for business growth.
To understand the strategies behind managing financing cash flow.
How Does Operating Cash Flow Differ From Free Cash Flow
Operating Cash Flow refers to amount of cash generated from company’s core business activities. Where as free cash flow refers to operating cash flow left to invest for business growth to pay back to the share holders as dividends after allowing for capital expenditures.
Your Next Steps to Improving Your Operating Cash Flow
Here are three options to help you take control and improve your business’s financial health:
Option 1: Explore Specific Subtopics on Operating Cash Flow
Dive deeper into key areas of operating cash flow. Whether you want to learn more about calculation methods, cash flow forecasting, or strategies to improve OCF, I have detailed subtopics tailored to your needs.
Option 2: Calculate Your Operating Cash Flow Using My Calculator
Use my free operating cash flow calculator and get instant clarity on your financial health.
[Download the Free Calculator]
Option 3: Book a Call with My Team to Fix Your Operating Cash Flow Faster
Book a call today, and let’s identify the specific strategies that will unlock your business’s growth.
Book a Call
Additional Resources
To deepen your understanding of operating cash flow, we’ve created a set of resources to guide you through your cash flow journey:
Get my Operating Cash Flow Calculator
Use our custom calculator to quickly assess your business’s current cash flow situation and identify areas for improvement.Download my Operating Cash Flow Forecast Template
Plan for future growth and cash challenges with our comprehensive cash flow forecast template.Get Your Free Guide: 10 Steps to Optimize Your Operating Cash Flow in 2024
This guide provides actionable steps to improve your cash flow and eliminate financial worries.