Question

How to calculate the cash transactions over the years from the earnings from Operations and cash from Operations. what is the formula between those two? and how can the cash transactions/flow be calculated from those numbers

Answer 1

What is Cash Flow from Operations?

Cash flow from operations is the section of a company’s cash flow statement that represents the amount of cash a company generates (or consumes) from carrying out its operating activities over a period of time. Operating activities include generating revenue, paying expenses, and funding working capital. It is calculated by taking a company’s (1) net income, (2) adjusting for non-cash items, and (3) accounting for changes in working capital.

Cash Flow from Operations Formula

While the exact formula will be different for every company (depending on the items they have on their income statement and balance sheet), there is a generic cash flow from operations formula that can be used:

Cash Flow from Operations = Net Income + Non-Cash Items + Changes in Working Capital

Cash Flow from Operations Example

Below is an example of Amazon’s operating cash flow from 2015 to 2017. As you can see in the screenshot below, the statement starts with net income, then adds back any non-cash items, and accounts for changes in working capital.

Follow these three steps:

1. Take net income from the income statement
2. Add back non-cash expenses
3. Adjust for changes in working capital

Cash Flow from Operations vs Net Income

Operating cash flow is calculated by starting with net income, which comes from the bottom of the income statement. Since the income statement uses accrual-based accounting, it includes expenses that may not have actually been paid for yet. Thus, net income has to be adjusted by adding back all non-cash expenses like depreciation, stock-based compensation, and others.

Once net income is adjusted for all non-cash expenses it must also be adjusted for changes in working capital balances. Since accountants recognize revenue based on when a product or service is delivered (and not when it’s actually paid), some of the revenue may be unpaid and thus will create an accounts receivable balance. The same is true for expenses that have been accrued on the income statement, but not actually paid.

Step 1: Start calculating operating cash flow by taking net income from the income statement.

Step 2: Add back all non-cash items. In this case, depreciation and amortization is the only item.

Step 3: Adjust for changes in working capital. In this case, there is only one line because the model has a separate section below that calculates the changes in accounts receivable, inventory, and accounts payable.

Cash Flow from Operations vs EBITDA

Earnings Before Interest Taxes Depreciation and Amortization (EBITDA) is one of the most heavily quoted metrics in finance. Financial Analysts regularly use it when comparing companies using the ubiquitous EV/EBITDA ratio. Since EBITDA doesn’t include depreciation expense, it’s sometimes considered a proxy for cash flow.

Since EBITDA excludes interest and taxes, it can be very different from operating cash flow. Additionally, the impact of changes in working capital and other non-cash expenses can make it even more different.

Learn more in CFI’s Business Modeling Courses.

Capital Expenditures

While operating cash flow tells us how much cash a business generates from its operations, it does not take into account any capital investments that are required to sustain or grow the business.

To get a complete picture of a company’s financial position, it is important to take into account capital expenditures (CapEx), which can be found under Cash Flow from Investing Activities.

Deducting capital expenditures from cash flow from operations gives us Free Cash Flow, which is often used to value a business in a discounted cash flow (DCF) model.

The Cash Flow Statement

Operating cash flow, or cash flow from operations (CFO), can be found in the cash flow statement, which reports the changes in cash versus its static counterparts: the income statement, balance sheet, and shareholders’ equity statement. Specifically, the cash flow statement reports where cash is used and generated over specific time periods and ties the static statements together.

By taking net income on the income statement and making adjustments to reflect changes in the working capital accounts on the balance sheet (receivables, payables, inventories), the operating cash flow section shows how cash was generated during the period. It is this translation process from accrual accounting to cash accounting that makes the operating cash flow statement so important.

The cash flow statement is broken down into three categories: cash flow from operating activities, cash flow from investing activities and cash flow from financing activities.1 In some cases, there is a supplemental activities category as well. These are segregated so that analysts develop a clear idea of all the cash flows generated by a company’s various activities.

1. Operating activities: records a company's operating cash movement, the net of which is where operating cash flow (OCF) is derived.
2. Investing activities: records changes in cash from the purchase or sale of property, plants, equipment, or generally long-term investments.
3. Financing activities: reports cash level changes from the purchase of a company’s own stock or issue of bonds and payments of interest and dividends to shareholders.
4. Supplemental information: basically everything that does not relate to the major categories.

Breakdown of Activities

Operating activities are normal and core activities within a business that generate cash inflows and outflows. They include:

• Total sales of goods and services collected during a period
• Payments made to suppliers of goods and services used in production settled during a period
• Payments to employees or other expenses made during a period

Cash flow from operating activities excludes money that is spent on capital expenditures, cash directed to long-term investments and any cash received from the sale of long-term assets. Also excluded are the amounts paid out as dividends to stockholders, amounts received through the issuance of bonds and stock and money used to redeem bonds.

Investing activities consist of payments made to purchase long-term assets, as well as cash received from the sale of long-term assets. Examples of investing activities are the purchase or sale of a fixed asset or property, plant, and equipment and the purchase or sale of a security issued by another entity.

Financing activities consist of activities that will alter the equity or borrowings of a company. Examples of financing activities include the sale of a company's shares or the repurchase of its shares.2

Calculating Cash Flow

To see the importance of changes in operating cash flows, it’s important to understand how cash flow is calculated. Two methods are used to calculate cash flow from operating activities: indirect and direct, which both produce the same result.

• Direct Method: This method draws data from the income statement using cash receipts and cash disbursements from operating activities. The net of the two values is the operating cash flow (OCF).
• Indirect Method: This method starts with net income and converts it to OCF by adjusting for items that were used to calculate net income but did not affect cash.

Direct Versus Indirect Method

The direct method adds up all the various types of cash payments and receipts, including cash paid to suppliers, cash receipts from customers and cash paid out in salaries. These figures are calculated by using the beginning and ending balances of a variety of business accounts and examining the net decrease or increase of the account.

The exact formula used to calculate the inflows and outflows of the various accounts differs based on the type of account. In the most commonly used formulas, accounts receivable are used only for credit sales and all sales are done on credit. If cash sales have also occurred, receipts from cash sales must also be included to develop an accurate figure of cash flow from operating activities. Since the direct method does not include net income, it must also provide a reconciliation of net income to the net cash provided by operations.

In contrast, under the indirect method, cash flow from operating activities is calculated by first taking the net income from a company's income statement. Because a company’s income statement is prepared on an accrual basis, revenue is only recognized when it is earned and not when it is received. Net income is not a perfectly accurate representation of net cash flow from operating activities; so, it becomes necessary to adjust earnings before interest and taxes (EBIT) for items that affect net income even though no actual cash has yet been received or paid against them. The indirect method also makes adjustments to add back non-operating activities that do not affect a company's operating cash flow.

The direct method for calculating a company's cash flow from operating activities is a more straightforward approach in that it reveals a company's operating cash receipts and payments, but it is more challenging to prepare since the information is difficult to assemble. Still, whether you use the direct or indirect method for calculating cash from operations, the same result will be produced.

Operating Cash Flows (OCF)

OCF is a prized measurement tool as it helps investors gauge what’s going on behind the scenes. For many investors and analysts, OCF is considered the cash version of net income, since it cleans the income statement of non-cash items and non-cash expenditures (depreciation, amortization, non-cash working capital and changes in current assets and liabilities).

OCF is a more important gauge of profitability than net income as there is less opportunity to manipulate OCF to appear more or less profitable. With the passing of strict rules and regulations on how overly creative a company can be with its accounting practices, chronic earnings manipulation can easily be spotted, especially with the use of OCF. It is also a good proxy of a company’s net income; for example, a reported OCF higher than NI is considered positive as income is actually understated due to the reduction of non-cash items.