Operating Cash Flow

What is operating cash flow?

Operating cash flow is the difference between all cash receipts and payments of a period that come from a company's ongoing business. It is also called cash flow from ongoing business activities or from operating activities (in German: Cashflow aus laufender Geschäftstätigkeit). Ongoing business includes payments from customers and to suppliers, employees, landlords and the tax office. It measures how much liquidity the core business generates or consumes. It does not include purchases and sales of fixed assets (investing activities) and payments from or to providers of capital such as investors and banks (financing activities).

For a kiosk, it would be the money left in the till after a month of sales once goods, the part-time helper and rent have been paid. The new refrigerated counter and the family loan with which it was paid for do not count.

The term comes from the cash flow statement, the schedule that arranges all payments of a period under these three areas. Its structure is governed by German Accounting Standard No. 21 (Deutscher Rechnungslegungs Standard, DRS 21). Companies that are not required to prepare a cash flow statement also determine operating cash flow in monthly reporting, in the financial model and before a financing round. Investors, banks and buyers use it to check whether the reported profit also arrives as cash.

Calculating operating cash flow: direct and indirect method

Direct method

The direct method presents the payments directly and thus follows the logic of liquidity planning:

Formula (direct method): Operating cash flow = receipts from customers minus payments to suppliers and employees minus other operating payments minus income taxes paid

This requires the bookkeeping to be able to analyse payments by these categories. DRS 21 permits both methods, but in published financial statements the direct method is rare.

Indirect method

The indirect method starts from the result for the period. It adjusts it for non-cash items that changed the result without cash flowing, such as depreciation, and for payments that have not yet been reflected in the result. The basic structure is as follows:

1. Result for the period (net income or net loss for the year)
2. plus depreciation, minus reversals of impairment on fixed assets
3. plus increase, minus decrease in provisions
4. minus increase, plus decrease in inventories and trade receivables
5. plus increase, minus decrease in trade payables, advance payments received and deferred income, which holds services paid in advance but not yet rendered
6. plus or minus other non-cash expenses and income
7. plus interest expense, minus interest income, to the extent that the interest payments sit in financing or investing activities under DRS 21
8. minus gains, plus losses from the disposal of fixed assets, because the sale proceeds belong to investing activities

Formula (indirect method, short form): Operating cash flow = result for the period + non-cash expenses minus non-cash income minus increase in working capital

Working capital is the money tied up in inventories and customer receivables less open supplier invoices; if it decreases, this raises operating cash flow. For interest and taxes, DRS 21 contains its own allocation rules. Income taxes paid generally belong to ongoing business activities. Interest paid is allocated by DRS 21 in principle to financing activities, interest and dividends received to investing activities. Older financial statements under the German Commercial Code (Handelsgesetzbuch, HGB) and IFRS financial statements for financial years before 2027 partly show interest in the operating area. The repayment of loans, by contrast, always belongs to financing activities and never reduces operating cash flow.

Operating cash flow and EBITDA

EBITDA, earnings before interest, taxes, depreciation and amortisation, is an earnings measure, whereas operating cash flow is a cash measure. Between the two lies above all the change in working capital. Added to this are income taxes paid, the change in provisions and other non-cash items, and, depending on the allocation, interest paid. A company whose customers buy on payment terms builds up additional receivables with every jump in revenue. Its operating cash flow then lags behind EBITDA even though the business is going well.

The ratio of operating cash flow to EBITDA is called cash conversion. A persistently low ratio indicates that earnings and liquidity are drifting apart, for example through longer payment terms, inventory build-up or income without cash receipt. The definition is not uniform in practice; some analysts deduct investments before dividing. How long working capital ties up liquidity is measured by the cash conversion cycle.

Influencing factors and room for manoeuvre

Operating cash flow reacts strongly to the timing of payments. Four effects are regularly to be examined in the analysis:

• Prepayments from customers: Software companies that bill annual licences in advance receive liquidity before they recognise the revenue under the HGB. The amount initially sits in deferred income or advance payments received and lifts cash flow above the result.
• Cut-off date management: Delayed payments to suppliers or accelerated collection of receivables shortly before the balance sheet date improve the reported figure without changing the business. A comparison with monthly figures makes such effects visible.
• Sale of receivables: In factoring, the company sells its customer receivables to a financial services provider, so the receivable amount flows in earlier. Operating cash flow rises once, although economically this is a financing.
• One-off payments: Tax refunds for prior years, settlement payments or catch-up payments to suppliers distort individual periods and are examined separately in due diligence.

Significance for growth companies and in transactions

For technology companies in the build-up phase, operating cash flow is regularly negative. Investors pay less attention to the absolute amount than to the development: whether the outflow per euro of new revenue is falling and from when the operating business sustains itself.

For the question of how long the existing money lasts (runway), it is not operating cash flow alone that counts but the net burn. This is the monthly net outflow of liquid funds excluding inflows from new financing. Besides operating cash flow, it includes investment payments and, as a rule, also interest and repayments on ongoing loans. For a company with loans, net burn is therefore higher than the outflow from operating cash flow and investments. If the ongoing business consumes EUR 100,000 a month, EUR 20,000 flow into investments and the company pays EUR 15,000 in interest and repayments, net burn is EUR 135,000.

In financial due diligence, operating cash flow is rebuilt from the monthly figures and reconciled with EBITDA. Buyers derive from it the sustainability of earnings and determine the normal level of working capital, which they use as a reference value in the purchase price calculation. After deducting investment payments, the result is free cash flow. It is used, among other things, in discounted cash flow valuations, which discount future cash surpluses to today.

Worked example: operating cash flow under the indirect method

A provider of connected measuring devices with a software subscription reports a net loss for the year of EUR 1.8 million. No interest or income taxes were incurred; the company is financed exclusively with equity. Calculation under the indirect method (amounts in EUR thousand):

• Net loss for the year: minus 1,800
• plus depreciation 300: minus 1,500
• plus increase in provisions 150: minus 1,350
• minus increase in trade receivables 400: minus 1,750
• minus increase in inventories 250: minus 2,000
• plus increase in trade payables 200: minus 1,800
• plus increase in deferred income from annual subscriptions paid in advance 500: minus 1,300
• minus book gain from the sale of a production machine 50: operating cash flow minus 1,350

EBITDA is minus 1,500 (net loss for the year plus depreciation). Operating cash flow comes out 150 better because prepayments, provisions and supplier payables (together 850) exceed the build-up of receivables and inventories (650) and the book gain that has been stripped out (50). After investment payments of 350 and the receipt of 80 from the sale of the machine, free cash flow is minus 1,620, around 135 per month. Because the company has no loans, this figure here equals net burn. Liquid funds of 2,700 therefore last 20 months on paper. Since at least 12 months of runway should remain at the start of a financing round, the process would have to begin within eight months at the latest.

With negative EBITDA as here, cash conversion cannot be meaningfully interpreted. A profitable comparison company with EBITDA of 2,000 and operating cash flow of 1,500 would arrive at a ratio of 75%.

Distinctions: operating cash flow, EBITDA, free cash flow and net burn

• EBITDA: earnings measure without the change in working capital, without tax payments and without the other non-cash items.
• Free cash flow: operating cash flow less investment payments; shows what remains for repayment, distributions or reserves.
• Cash flow from investing and financing activities: the two other areas of the cash flow statement, for the purchase and sale of fixed assets and for payments with providers of capital.
• Net burn: the monthly net outflow of funds of a growth company including investments and, as a rule, interest and repayments; the basis of runway.

Common mistakes

• Signs of the working capital change reversed. An increase in receivables reduces operating cash flow, an increase in supplier payables raises it. Reversed signs are noticed only on reconciliation with the bank balance.
• Asset sales left in the operating area. Book gains are to be stripped out; the sale proceeds belong to investing activities.
• VAT overlooked. Payments include VAT, income does not. In the direct method and in liquidity planning, VAT payments and input VAT refunds are to be recorded separately.
• Only annual figures considered. Seasonal fluctuations and cut-off date effects stay hidden; monthly figures are required to assess a growth company.

Frequently asked questions

What is a good operating cash flow?

A persistently positive operating cash flow that grows with the business and covers ongoing investments as well as interest and repayments. There is no universally valid target value, because the amount depends on company size. It becomes comparable as a ratio, for example in relation to revenue (cash flow margin) or to EBITDA (cash conversion).

Is a negative operating cash flow a warning sign?

Not necessarily. In the build-up phase of a technology company it is the rule and is financed with equity. What matters is whether the outflow follows the plan, falls in relation to growth and whether the existing funds last until the next milestone.

Can operating cash flow be higher than net income for the year?

Yes; for companies with high depreciation this is the normal case. Rising provisions, prepayments from customers or a reduction in receivables also lift operating cash flow above the result.

Where is operating cash flow found in the annual financial statements of a GmbH?

Usually nowhere, because a cash flow statement is not mandatory for most GmbHs (German limited liability companies). The figure is then derived from two consecutive balance sheets and the income statement under the indirect method.

What role does operating cash flow play in a bank loan?

It is the starting point for debt service capacity, that is, the question of whether interest and repayments can be paid from the ongoing business. For this, banks derive a cash flow from operating cash flow or, in simplified form, from earnings and depreciation. Because repayment is not included in operating cash flow, it must, after necessary investments, cover the entire debt service with a buffer. The ratio of the two is called the debt service coverage ratio.

The Roemer Capital view

In preparing a financing round, Roemer Capital derives operating cash flow month by month from the bookkeeping and bank balances and explains every deviation from EBITDA. Investors ask early how much liquidity the business consumes per euro of revenue and when this ratio reverses. A robust reconciliation answers this before doubts about the figures arise.

Net burn, and from it runway, results from operating cash flow, planned investments and the debt service on ongoing loans. At the start of the process, runway should be 12 to 18 months, because a financing round takes 6 to 8 months and only those who are not under time pressure keep room to negotiate. In the financial model, Roemer Capital calculates the figure in the base case, the cautious case and the optimistic case.