How Do You Calculate Operating Cash Flow?

Today’s guest blogger is Matt McCall of Draper Fisher Jurvetson Portage. Matt writes a popular blog called VC Confidential.

Matt takes on the following question: What are some of the best ways you’ve seen to sensibly estimate and/or calculate capital and/or operating cash flow, and how do you like to see this presented to an investor?

Cash is the life’s blood of any company. It comes from either the company’s operations or from raising capital.  There are a number of definitions of cash flow. I prefer to focus on what the core operating business is generating or burning net of any financing activity. As a result, I look at Operating Cash Flow minus Cap-X. A gross generalization of this includes (apologies to all of my accounting & finance profs):

Net Income
plus depreciation, amortization and other non-cash cash income statement items
minus working capital needs
minus core, recurring capital expenditures (exclude large one time charges)

Since both working capital and cap-x can vary significantly monthly, you should average across a period of time that smooths out the swings such as the average monthly cash flow for a 3 or 6 month period. You should also understand how this changes as your business ramps since it will impact your financing needs.

I define capital as debt plus equity. Should your business consume cash (as defined above), you will need to finance it through either raising equity or taking on debt. This can include facilities such as working capital lines to finance receivables and inventory or lease lines to finance capital expenditures.

In the end, cash flow and capital are two sides of the same coin.

  • Could you give an example of ‘core, recurring capital expenditures’?
    Also, I understand why you would include interest income in your evaluation of ‘whether the business needs money’, but it seems like it can mislead the readout on the general health of the business. Thoughts?

  • My version (as a banker):
    Net Income
    plus depreciation, amortization and other non-cash
    plus exec bonuses
    plus any non-recurring exec payments/ loans

    minus plus working capital needs
    minus core, recurring capital expenditures (exclude large one time charges)

  • Everyone will adjust my approach above to fit the specifics of their business. You can decide to subtract out interest charges if you choose under the assumption that this expense is not related to you core operations but rather to your financing decisions. I have included it since traditional cash flow from operations contains it. Some would also argue to take taxes out (e.g. start with EBITDA). However, in my opinion, if you are fortune enough to be profitable, then Uncle Sam is an every day part of your expense structure and impacts cash flow.
    Regarding calculating your core cap-x, you need to determine what cap-x you need to spend over the course of some period (say a year) to maintain your operations and support your growth. This is usually pretty lumpy. For example, let’s say that you need to buy $200,000 worth of servers and other hardware every 4 months. This would equal $50,000 per month even though you had to buy capacity in a step function.
    Good catch on the Working Capital…it is plus or minus. Regarding bonuses, I have tended also not to factor out bonuses since all of our companies have bonus plans tied to results (sales, product version delivery, etc) and we view this as the equivalent of sales commission. Also, it can create a misleading view of the business if management starts gaming this by moving more and more of their take into bonus. We would consider factoring out one-time charges like severance.