Cash flow from operations: what it is and how to calculate it

Published Monday 22 December 2025

Table of contents

• Understanding the components of cash flow from operations
• How to calculate cash flow from operations: a step-by-step guide
• Cash flow from operations vs net income
• Cash flow from operations vs free cash flow
• Strategies to improve cash flow
• Streamline your cash flow with Xero
• FAQs on cash flow from operations

Key takeaways

• Calculate your operating cash flow regularly using either the indirect method (net income + non-cash expenses + working capital changes) or direct method (total cash inflows - total cash outflows) to understand your business's true financial health beyond what profit figures show.
• Focus on improving cash collection by sending invoices promptly, offering multiple payment options, and negotiating better supplier payment terms to increase the actual cash flowing through your daily operations.
• Monitor your operating cash flow weekly rather than waiting for annual reports, as this metric provides a more accurate picture of your business sustainability than net income alone since it excludes non-cash expenses like depreciation.
• Distinguish between operating cash flow and free cash flow to make better financial decisions: operating cash flow shows money from daily activities, while free cash flow reveals what's available after essential capital expenditures for debt payments or reinvestment.

Understanding the components of cash flow from operations

Three key components make up your cash flow from operations calculation:

• Net income: Your total profit after all expenses, found at the bottom of your income statement. Read this net income calculation guide for more information.
• Non-cash items: Paper losses that don't involve actual cash leaving your business (like equipment depreciation)
• Working capital changes: The difference between current assets (cash, inventory, money owed to you) and current liabilities (bills due, short-term debts)

A cash flow from operations formula will combine these components to tell you how much operating cash flow you have.

How to calculate cash flow from operations: a step-by-step guide

Two calculation methods help you determine your operating cash flow. Both give the same result but use different starting points.

Indirect method

Indirect method steps:

1. Start with net income from your income statement
2. Add back non-cash expenses like depreciation (these don't affect actual cash)
3. Adjust for working capital changes (increases in assets reduce cash flow, increases in liabilities improve it)

Here's the formula:

OCF = net income + non-cash expenses + changes in working capital

Direct method

Direct method steps:

1. List all cash received from customers and operations
2. List all cash paid for operating expenses
3. Subtract total outflows from total inflows to get your operating cash flow

Here's the formula:

OCF = total cash inflows - total cash outflows

Which method to choose

Both methods give identical results but serve different needs:

• Indirect method: Easier to calculate using existing financial statements
• Direct method: Provides detailed breakdown of actual cash transactions

Want to save time? The Financial Reporting Council notes that most errors in cash flow statements can be avoided with robust reviews, and smart accounting software can help by taking care of the calculations for you.

Xero uses your real-time bookkeeping data to generate accurate, reliable reports and provide a clear view of your operating cash flow. You can also use Xero's cash flow calculator to help you crunch the numbers.

Example of cash flow from operations

Let's use the indirect method formula.

Sweet Tooth Dental reported a net income of £40,000 for the last financial year. They had £4,000 in non-cash expenses due to the depreciation of medical machinery. Throughout the year, there were some changes in working capital:

• Current assets increased by £2,000 because some patients bought on credit and have not settled their bills yet. Inventory increased by £1,000 as they purchased new surgical kits and protective equipment.
• Current liabilities increased by £1,000, as they postponed paying some suppliers.

Using the indirect method, Sweet Tooth Dental's operating cash flow calculation looks like this:

OCF = £40,000 + £4,000 − £3,000 + £1,000

Operating cash flow = net income + non-cash items − increase in current assets + increase in current liabilities

The cash flow calculation shows Sweet Tooth Dental has an OCF of £42,000. This means Sweet Tooth Dental generated £46,000 from its dentistry operations in the previous financial year.

Cash flow from operations vs net income

It's easy to confuse operating cash flow with net income, but they tell you different things about your business's financial health.

Net income, or profit, is what's left after you subtract all your expenses from your revenue. You'll find it at the bottom of your income statement. However, net income includes non-cash expenses like depreciation. This means a business can look profitable on paper even when there isn’t enough cash on hand to pay bills comfortably.

Operating cash flow gives you a truer picture of your cash position by adding those non-cash expenses back to the net income. It shows you the actual cash your core business activities are generating, making it a more reliable indicator of your short-term financial stability.

Cash flow from operations vs free cash flow

Operating cash flow (OCF) and free cash flow (FCF) are both important, but they measure different things. OCF shows the cash generated from your normal day-to-day operations.

Free cash flow takes this a step further. You calculate it by subtracting any money you've spent on large assets, like property or equipment (known as capital expenditures), from your OCF. FCF shows you the cash that's available to pay back investors, settle debts, or reinvest in the business after all essential spending is covered. Think of it as the cash your business is free to use however it likes.

Strategies to improve cash flow

Better operating cash flow gives you financial stability and growth opportunities. More available cash means less stress about bills and emergencies.

You can shift from reactive money management to proactive business investment.

Speed up customer payments

Send invoices promptly and offer multiple payment options to reduce collection time. If you're using Xero, you can add payment providers such as Stripe and GoCardless to give your customers more ways to pay.

Optimize supplier timing

Negotiate better payment terms while maintaining good relationships. Make sure you notify suppliers before delaying your payment schedule. And always pay on time to protect relationships and avoid late payment fees.

Reduce excess inventory

Stock only what you need based on sales data to free up tied-up cash. Create an inventory report to see what you're selling each month and base your stock levels on this data.

Control expenses

Focus spending on essentials and eliminate unused subscriptions. Try to focus your spending on the essentials, and regularly monitor what moves out of your account. Do away with the unused subscriptions and charges that can easily go unnoticed.

Monitor cash position

Check your cash flow weekly to spot issues early, as managing liquidity risk is a major focus in tough economic conditions. Your cash flow position isn't fixed; it changes every time you get paid or make a purchase. Producing a cash flow statement regularly can help you understand all aspects contributing to your business's financial health. That kind of clarity lets you make better-informed financial decisions.

Create cash flow forecasts

Predict future cash needs using accounting software to plan ahead. A cash flow statement is great for the here and now, but ideally you want to understand what's up ahead. That's where cash flow forecasts come in, and they're easily created using cloud-based accounting software.

Streamline your cash flow with Xero

Xero accounting software gives you a clear view of all types of cash flow, so you have the tools and knowledge to make smart financial decisions. Produce cash flow forecasts and statements that are simple to read and act on.

For more on managing your business finances, visit the Xero cash flow content hub.

Ready to take control of your cash flow? Try Xero for free and see how easy it can be to track your operating cash flow in real time.

FAQs on cash flow from operations

Understanding cash flow from operations can bring up a few questions. Here are answers to some common ones.

What is the difference between operating cash flow and free cash flow?

Operating cash flow (OCF) is the cash generated from your main business activities. Free cash flow (FCF) is what's left after you subtract capital expenditures (money spent on assets like equipment) from your OCF. It's the cash available for paying down debt or returning to owners.

Can a profitable business have negative operating cash flow?

Yes. A business can report a profit but have negative operating cash flow. This often happens if customers are slow to pay their invoices or if you're building up a lot of inventory. Profit on paper doesn't always mean you have cash in the bank.

How often should I calculate my operating cash flow?

It's a good idea to review your operating cash flow monthly. This helps you spot trends, manage your finances proactively, and make informed decisions without waiting for annual reports. Using accounting software can give you a real-time view.

What's considered a good operating cash flow for a small business?

A positive operating cash flow is always the goal, as it means your core business can generate enough cash to sustain itself. There isn't a single magic number, as a 'good' OCF depends on your industry and business size. The key is to see consistent, positive cash flow over time.