There are 30.2 million small businesses in the US alone — and they make up almost half of the country’s workforce.
All of these businesses live and die by their cash flow. This means it’s crucial to be able to assess your company’s cash flow and how it is impacted by taxes. This skill is very important for being able to assess your company’s overall health.
In this article, we’ll tell you how to calculate your operating cash flow, what it means, and the tax services that can help you take advantage of it.
Keep reading to learn more.
What Is Operating Cash Flow?
Operating Cash Flow (OCF) is a useful tool that refers to the amount of cash made through the regular operating activities of a business within a set period of time.
Analyzing cash flow gives you valuable insight into the financial health of your business. You can assess this with different methods depending on the type of cash flow activity.
With this information, executives can make better decisions on how to operate and what expenses to make and cut. Cash flow is also used as a way to prove that a business is creditworthy to investors and lenders.
How to Calculate Taxes in Operating Cash Flow
The simple formula for calculating operating cash flow is as follows:
EBIT + Depreciation – Taxes = Operating Cash Flow
EBIT, also known as earnings before interest and taxes, refers to how much a business makes from its revenue before calculating operating expenses.
In order to figure out the operating cash flow, the company must first also track the depreciation of assets that are used for the business’s operations. After that, this amount is added to the EBIT. Finally, the amount of business tax owed must be subtracted to reach the final operating cash flow.
Let’s take a look at an example.
Let’s say a business earns $500,000 in revenue. Their operating expenses which include equipment, salaries, and materials equal $400,000. To find the EBIT, subtract $400,000 from the $500,000 to equal $100,000.
Let’s say the company’s asset depreciation equals $60,000, and taxes owed are $75,000.
After plugging these figures into the formula, it would look like this:
Operating Cash Flow = $100,000 +$60,000 – $75,000
This company has an operating cash flow of $85,000.
Usually, businesses will calculate their taxes by multiplying the tax rate by the amount of taxable income made by the business. Once a business analyzes its operating cash flow, it can get a clear picture of how tax is impacting its business.
Effective Ways to Manage Your Cash Flow
The Impact of Taxes on Cash Flow
Figuring out your business’s operating cash flow is a great way to see if it can generate enough revenue to maintain or grow its operations and for tax planning. If the operating cash flow isn’t high enough, it may need to look to external sources for more financing.
If the business has shorter turnover rates in inventory and shorter times to receive more funds, it can help increase the operational cash flow.
Depreciation and taxes are added to the formula so that it can give you a more accurate picture of the overall net income. If your business has higher taxes and lower depreciation methods, it will also lower the impact on your operational cash flow.
Implications of Your Operating Cash Flow
Your taxes and cash flow are key factors that investors will look at when analyzing the strength of the business. It indicates the company’s ability to pay dividends.
The better their operating cash flow is, the better the company is doing financially. This puts it in a better position to make distributions.
A few items excluded from the operating cash flow formula include income made from outside of a business’s operations, infrequent long-term expenses, and any dividends paid.
Limitations of Cash Flow
Although it can be very useful, cash flow analysis does have its limitations when determining the success of a business.
First, the cash flow statement only focuses on the income and expenses that flow in and out of the business. It doesn’t include other important assets such as intellectual property or equipment.
It also doesn’t include other intangible factors that are essential for growth, like customer base or reputation. Also, if your business has money flowing in from a loan, it is not taken into account for cash flow.
It’s also important to keep in mind that cash flow does not mean the same thing as profitability, which is another important indicator when assessing a business’s financial strength. They are two separate metrics that display different perspectives of a business.
For example, a business can have a positive cash flow but not have any profit. On the other hand, it can be generating good profits, but have a negative cash flow.
Seek professional accounting services for more information.
Other Important Tax Facts Regarding Your Cash Flow
There are a few more things to keep in mind when it comes to taxes and your cash flow.
For example, some businesses might want to look at their before-tax cash flow instead of their after-tax cash flow. These businesses might want to track their progress and spending habits before taxes are added in. By doing this, they can solely focus on revenue made after operating and capital costs.
Another important thing for businesses to understand is deferred income tax. This is the amount of tax that hasn’t been paid yet but is expected to be owed. This often happens when assets are depreciated using different methods, causing a difference between amounts.
Finding the Best Tax Services for Your Business or Personal Finances
Strategize and Optimize Your Business’s Cash Flow With Professional Tax Services
Now that you understand the basics of operational cash flow, it’s time to take your business to the next level.
Planning your taxes can be complicated for small businesses. If you’re looking for a comprehensive suite of tax services that can help your business optimize its finances, look no further. Reach out to us today for tax resolution!