Operating Cash Flow vs. Free Cash Flow (2024)

FAQs

Operating Cash Flow vs. Free Cash Flow? ›

Operating cash flow tells investors whether a company has enough cash flow to pay its bills and turn a profit. Free cash flow tells investors and creditors that there's enough cash remaining to pay back creditors, pay dividends, and buy back shares.

Free cash flow helps estimate the current value of a company, while operating cash flow can tell business leaders how much revenue their core operations generate. Executives might use free cash flow to get a sense of how much the business might be worth to an investor or buyer.

Operating cash flow (OCF) is the lifeblood of a company and arguably the most important barometer that investors have for judging corporate well-being. Although many investors gravitate toward net income, operating cash flow is often seen as a better metric of a company's financial health for two main reasons.

The generic Free Cash Flow (FCF) Formula is equal to Cash from Operations minus Capital Expenditures. FCF represents the amount of cash generated by a business, after accounting for reinvestment in non-current capital assets by the company.

The indirect method backs into the net operating cash flow value using the calculated net income and non-cash adjustments, so there is more room for errors and redundancies. Instead, the direct method is more clear in how it's calculated and can give you a better idea of your current cash standing.

The best things in life are free, and that holds true for cash flow. Smart investors love companies that produce plenty of free cash flow (FCF). It signals a company's ability to pay down debt, pay dividends, buy back stock, and facilitate the growth of the business.

Cash flow is seen as a straightforward measure of the net cash that came into or left the business during a given period of time. Free cash flow is a figure that tells investors how much cash your business has on hand after funding its operating and investing needs. This free cash flow can be used for: Share buybacks.

Operating Cash Flow Ratio Analysis

Generally, a ratio over 1 is considered to be desirable, while a ratio lower than that indicates strained financial standing of the firm.

Operating cash flow (OCF) is a measure of the amount of cash generated by a company's normal business operations. Operating cash flow indicates whether a company can generate sufficient positive cash flow to maintain and grow its operations, otherwise, it may require external financing for capital expansion.

Positive cash flow indicates that a company's liquid assets are increasing. This enables it to settle debts, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges.

What is a good free cash flow ratio? ›

A “good” free cash flow conversion rate would typically be consistently around or above 100%, as it indicates efficient working capital management. If the FCF conversion rate of a company is in excess of 100%, that implies operational efficiency.

When there is no cash left over after meeting operating, capital, and adjusting for non-cash expenses, a company has negative free cash flow. This means that the company has no excess cash on hand in a given period, which could be a sign of poor financial health.

Some investors prefer to use FCF or FCF per share rather than earnings or earnings per share (EPS) as a measure of profitability because the latter metrics remove non-cash items from the income statement.

Operating cash flow

A company's operating cash flow offers a portrait of its day-to-day operating activities: namely, the income from sales and outflows from salaries, vendor fees, lease payments, taxes, and interest payments. A company whose sales exceed its operating expenses is cash flow positive.

Free cash flow is an important measurement since it shows how efficient a company is at generating cash. Investors use free cash flow to measure whether a company might have enough cash, after funding operations and capital expenditures, to pay investors through dividends and share buybacks.

A high number, greater than one, indicates that a company has generated more cash in a period than what is needed to pay off its current liabilities. An operating cash flow ratio of less than one indicates the opposite—the firm has not generated enough cash to cover its current liabilities.

Disadvantages of Free Cash Flow

A very high free cash flow may indicate that a company is not investing enough in its business venture. A low CFC does not always mean poor financial standing. It often signifies heavy growth and expansion.

Benefits of Free Cash Flow

Because FCF accounts for changes in working capital, it can provide important insights into the value of a company and the health of its fundamental trends.

A higher free cash flow margin suggests that the company is effectively controlling its costs and is efficient in its operations. It's a sign of a healthy, well-run business with the potential for growth and profitability.

Operating cash flow margin uses operating cash flow and not operating income. Free cash flow margin is another cash margin measure, where it also adds in capital expenditures.