Cash Flow From Operating Activities (CFO)

What Is Cash Flow From Operating Activities (CFO)?

Cash flow from operating activities (CFO) shows the amount of money a company gets from its progressing, standard business activities, like manufacturing and selling goods or offering a support to customers. It is the primary section portrayed on a company's cash flow statement.

Cash flow from operating activities does exclude long-term capital expenditures or investment revenue and expense. CFO centers just around the core business, and is otherwise called operating cash flow (OCF) or net cash from operating activities.

Grasping Cash Flow From Operating Activities (CFO)

Cash flow forms one of the main parts of business operations and accounts for the total amount of money being moved into and out of a business. Since it influences the company's liquidity, it has significance because of various factors. It permits business owners and administrators check where the money is coming from and going to, it assists them with doing whatever it may take to create and keep up with adequate cash essential for operational productivity and other vital necessities, and it assists in pursuing with keying and efficient financing choices.

The insights regarding the cash flow of a company are available in its cash flow statement, which is part of a company's quarterly and annual reports. The cash flow from operating activities portrays the cash-producing capacities of a company's core business activities. It normally incorporates net income from the income statement and changes in accordance with modify net income from a accrual accounting basis to a cash accounting basis.

Cash availability permits a business the option to grow, build and send off new products, buy back shares to certify their strong financial position, pay out dividends to reward and support shareholder confidence, or reduce debt to save money on interest payments. Investors endeavor to search at companies whose share costs are lower and cash flow from operations is showing a vertical trend over recent quarters. The disparity shows that the company has expanding levels of cash flow which, assuming better used, can lead to higher share prices in not so distant future.

Positive (and expanding) cash flow from operating activities shows that the core business activities of the company are flourishing. It gives as extra measure/sign of profitability capability of a company, notwithstanding the traditional ones like net income or EBITDA.

Cash Flow Statement

The cash flow statement is one of the three principal financial statements required in standard financial reporting notwithstanding the income statement and balance sheet. The cash flow statement is partitioned into three sections — cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities. On the whole, each of the three sections give an image of where the company's cash comes from, the way things are spent, and the net change in cash coming about because of the association's activities during a given accounting period.

The cash flow from investing section shows the cash used to purchase fixed and long-term assets, for example, plant, property, and equipment (PPE), as well as any proceeds from the sale of these assets. The cash flow from financing section shows the source of a company's financing and capital as well as its servicing and payments on the loans. For instance, proceeds from the issuance of stocks and bonds, dividend payments, and interest payments will be incorporated under financing activities.

Investors look at a company's cash flow from operating activities, inside the cash flow statement, to determine where a company is getting its money from. As opposed to investing and financing activities which might be one-time or irregular revenue, the operating activities are core to the business and are recurring in nature.

Types of Cash Flow from Operating Activities

The cash flow from operating activities section can be shown on the cash flow statement in one of two ways.

Indirect Method

The main option is the indirect method, where the company starts with net income on an accrual accounting basis and works in reverse to accomplish a cash basis figure for the period. Under the accrual method of accounting, revenue is recognized when earned, not really when cash is received.

For instance, in the event that a customer buys a $500 gadget on credit, the sale has been made yet the cash has not yet been received. The revenue is as yet recognized by the company in the period of the sale, and it appears in net income on its income statement.

Hence, net income was exaggerated by this amount on a cash basis. The offset to the $500 of revenue would show up in the accounts receivable detail on the balance sheet. On the cash flow statement, there would should be a reduction from net income in the amount of the $500 increase to accounts receivable due to this sale. It would be shown on the cash flow statement as "Increase in Accounts Receivable - $500."

Direct Method

The subsequent choice is the direct method, in which a company records all transactions on a cash basis and presentations the data on the cash flow statement utilizing genuine cash inflows and outflows during the accounting period.

Instances of the direct method of cash flows from operating activities include:

• Salaries paid out to workers
• Cash paid to sellers and providers
• Cash collected from customers
• Interest income and dividends received
• Income tax paid and interest paid

Indirect Method versus Direct Method

Numerous accountants favor the indirect method since it is simple to prepare the cash flow statement utilizing data from the income statement and balance sheet. Most companies utilize the accrual method of accounting, so the income statement and balance sheet will have figures predictable with this method.

The Financial Accounting Standards Board (FASB) suggests that companies utilize the direct method as it offers a clearer image of cash flows all through a business. Notwithstanding, as an additional complexity of the direct method, the FASB likewise requires a business utilizing the direct method to unveil the reconciliation of net income to the cash flow from operating activities that would have been reported assuming the indirect method had been utilized to prepare the statement.

The reconciliation report is utilized to check the exactness of the cash from operating activities, and it is like the indirect method. The reconciliation report starts by listing the net income and adjusting it for noncash transactions and changes yet to be determined sheet accounts. This additional task makes the direct method disliked among companies.

Indirect Method Formulas for Calculating Cash Flow from Operating Activities

Different reporting standards are trailed by companies as well as the different reporting elements which might lead to various estimations under the indirect method. Contingent on the available figures, the CFO value can be calculated by one of the accompanying formulas, as both yield a similar outcome:

Cash Flow from Operating Activities = Funds from Operations + Changes in Working Capital

where, Funds from Operations = (Net Income + Depreciation, Depletion, and Amortization + Deferred Taxes and Investment Tax Credit + Other Funds)

This arrangement is utilized for reporting Cash Flow subtleties by finance portals like MarketWatch.

Or then again

Cash Flow from Operating Activities = Net Income + Depreciation, Depletion, and Amortization + Adjustments To Net Income + Changes In Accounts Receivables + Changes In Liabilities + Changes In Inventories + Changes In Other Operating Activities

This organization is utilized for reporting Cash Flow subtleties by finance portals like Yahoo! Finance.

Every one of the previously mentioned figures included above are available as standard details in the cash flow statements of different companies.

The net income figure comes from the income statement. Since it is prepared on an accrual basis, the noncash expenses recorded on the income statement, like depreciation and amortization, are added back to the net income. Moreover, any changes in balance sheet accounts are likewise added to or deducted from the net income to account for the overall cash flow.
Inventories, tax assets, accounts receivable, and accrued revenue are common things of assets for which a change in value will be reflected in cash flow from operating activities. Accounts payable, tax liabilities, deferred revenue, and accrued expenses are common instances of liabilities for which a change in value is reflected in cash flow from operations.

Starting with one reporting period then onto the next, any positive change in assets is backed out of the net income figure for cash flow estimations, while a positive change in liabilities is added once more into net income for cash flow computations. Basically, an increase in an asset account, for example, accounts receivable, means that revenue has been recorded that has not really been received in cash. Then again, an increase in a liability account, for example, accounts payable, means that an expense has been recorded for which cash has not yet been paid.

Illustration of Cash Flow from Operating Activities

We should take a gander at the cash flow subtleties of the leading technology company Apple Inc. (AAPL) for the fiscal year ended September 2018. The iPhone maker had a net income of $59.53 billion, Depreciation, Depletion, and Amortization of $10.9 billion, Deferred Taxes and Investment Tax Credit of - $32.59 billion, and Other Funds of $4.9 billion.

Following the principal formula, the summation of these numbers brings the value for Fund from Operations as $42.74 billion. The net Change in Working Capital for a similar period was $34.69 billion. Adding it to Fund from Operations gives the Cash Flow from Operating Activities for Apple as $77.43 billion.

For the subsequent method, summarizing the available values from Yahoo! Finance portal that reports Apple's FY 2018 Net Income $59.531 billion, Depreciation $10.903 billion, Adjustments To Net Income - $27.694 billion, Changes In Accounts Receivables - $5.322 billion, Changes In Liabilities 9.131 billion, Changes In Inventories $.828 billion, and Changes In Other Operating Activities $30.057 billion gives the net CFO value as $77.434 billion.

Both the methods yield a similar value.

Special Considerations

One must note that working capital is an important component of cash flow from operations, and companies can control working capital by postponing the bill payments to providers, speeding up the assortment of bills from customers, and deferring the purchase of inventory. This multitude of measures permit a company to hold cash. Companies likewise have the liberty to set their own capitalization limits, which permit them to set the dollar amount at which a purchase qualifies as a capital expenditure.

Investors ought to know about these contemplations while contrasting the cash flow of various companies. Due to such flexibility where managers are able to control these figures partially, the cash flow from operations is all the more commonly utilized for checking on a single company's performance north of two reporting periods, as opposed to contrasting one company with another, even on the off chance that the two belong in a similar industry.

Features

• Cash flow from operating activities is the main section portrayed on a cash flow statement, which likewise incorporates cash from investing and financing activities.
• There are two methods for portraying cash from operating activities on a cash flow statement: the indirect method and the direct method.
• The indirect method starts with net income from the income statement then adds back noncash things to show up at a cash basis figure.
• Cash flow from operating activities is an important benchmark to determine the financial outcome of a company's core business activities.
• The direct method tracks all transactions in a period on a cash basis and utilizations genuine cash inflows and outflows on the cash flow statement.