Operating Cash Flow

Operating cash flow is just the cash generated by operations. It is calculated as the sum of net operating profit after taxes (NOPAT) and any noncash adjustments to income, such as depreciation. The following accounting equation works for a simple company:

The idea behind calculating operating cash flow rather than more common measures such as net income or earnings before interest and taxes (EBIT) is that it is important to know the actual cash generated by operations. A hospital can only pay its bills with cash, not with accounting earnings! Accounting rules require that many noncash and nonoperating items appear in the net income calculation, and these items obscure what is happening to operations and cash. Depreciation is charged off even though the company doesn't ever write a check to pay depreciation. Interest income and interest expense are recognized even though they are the result of financing choices, not operating decisions. And all sorts of extraordinary and one-time items such as restructuring charges appear in net income. In short, if an analyst is interested in evaluating the core operations of a company, net income is often a poor measure to use. Operating cash flow is a better measure.