Cash flow from operations: the formula, three worked examples, and what it tells you

Short answer: cash flow from operations (also called operating cash flow, or net cash from operating activities) is the cash the business’s day-to-day trading actually brought in over a period: money received from customers, less money paid to suppliers, staff, the landlord and the tax office. It leaves out buying or selling equipment (investing) and loans, owner money, drawings and dividends (financing). The quick way to work it out from your accounts is net profit + depreciation − increase in debtors − increase in stock + increase in creditors − tax paid. If it is positive, trading pays for itself; if it is lower than profit, the difference is usually sitting in unpaid invoices or on the shelves; if it is negative for several periods in a row, something else (the bank balance, a loan, the owner) is paying for the business.

The cash flow from operations formula

There are two ways to write it, and both give the same answer.

From your profit (the indirect method):

• Net profit before tax
• + depreciation and amortisation (costs that used no cash this period)
• − increase in trade debtors (or + a decrease)
• − increase in stock (or + a decrease)
• + increase in trade creditors and accruals (or − a decrease)
• = cash generated from operations
• − income tax or company tax paid
• = cash flow from operations

From the bank (the direct method):

• Cash received from customers
• − cash paid to suppliers and staff (including rent, wages and running costs)
• − GST or VAT paid to the tax office (net of refunds)
• − interest and tax paid
• = cash flow from operations

On £500,000 of sales and £60,000 of profit, with £5,000 of depreciation, customers owing £15,000 more at the end of the year than at the start, no change in stock or creditors, and £11,000 of tax paid, cash flow from operations is 60,000 + 5,000 − 15,000 − 11,000 = £39,000.

Two ratios are worth knowing:

• Cash conversion = cash flow from operations ÷ net profit × 100. Near or above 100% means profit is turning into cash; well below means it is getting stuck.
• Operating cash flow margin = cash flow from operations ÷ sales × 100: how much cash each £100 of sales leaves behind.

Three businesses, the same profit, very different cash

These are made-up figures for three UK limited companies over one year. Each made exactly £80,000 of net profit before tax, and each paid £16,000 of last year’s corporation tax during the year. Every figure excludes VAT.

• An IT consultancy: £300,000 of sales, almost no stock, clients pay within a month.
• A homewares wholesaler: £900,000 of sales, buys stock ahead of the Christmas season.
• A building firm: £700,000 of sales, two large jobs invoiced in the last two months of the year, with retentions held back by the main contractor.

	Consultancy (£)	Wholesaler (£)	Builder (£)
Net profit before tax	80,000	80,000	80,000
Add back depreciation	2,000	6,000	10,000
Increase in debtors	(2,000)	(12,000)	(70,000)
Increase in stock	–	(40,000)	(5,000)
Increase / (decrease) in creditors	1,000	10,000	(8,000)
Cash generated from operations	81,000	44,000	7,000
Corporation tax paid	(16,000)	(16,000)	(16,000)
Cash flow from operations	65,000	28,000	(9,000)
Cash conversion (÷ profit)	81%	35%	negative
Operating cash flow margin (÷ sales)	21.7%	3.1%	−1.3%

Brackets are minus figures. The same £80,000 of profit means three different things:

1. The consultancy’s profit is cash. £65,000 of the £80,000 arrived in the bank, and £16,000 of the gap is tax that was owed from last year anyway. It can pay its directors, repay loans or build a reserve from trading alone.
2. The wholesaler’s profit went onto the shelves. Stock rose from £120,000 to £160,000. On £630,000 of cost of sales that is about 93 days of stock at year end, up from about 70 (160,000 ÷ 630,000 × 365, and 120,000 ÷ 630,000 × 365). Suppliers funded £10,000 of it by being paid later; the rest came from the profit. If the extra stock sells in the new year the cash comes back, and if it does not, part of that £80,000 profit will turn into a stock write-down. The stock days guide shows how to track this month by month.
3. The builder made a profit and lost cash. Customers owed £140,000 at year end, up from £70,000: 140,000 ÷ 700,000 × 365 = 73 days of sales, against about 37 a year earlier. It also paid suppliers faster (creditors fell £8,000). Trading used £9,000 of cash in a year that showed £80,000 of profit, so any dividends, van payments or loan repayments came out of the bank balance or the overdraft. Getting back to 37 days would release about £70,000. The free debtor days calculator does this sum on your own figures, and who owes me money? shows how to find the invoices behind it in Xero.

An owner reading only the Profit and Loss would think the three businesses had the same year. Cash flow from operations shows that one of them needs a conversation with its customers and its bank. Before that conversation, work out its cash flow cover: the ratio a bank uses to judge whether trading cash pays the loan repayments.

What counts as operating cash flow, and what does not

In cash flow from operations	Not in it (where it goes instead)
Receipts from customers	Buying or selling equipment, vehicles, property (investing)
Payments to suppliers, subcontractors and staff	Loans received and loan principal repaid (financing)
Rent, insurance, software, vehicle running costs	Money the owners put in (financing)
GST or VAT paid to, or refunded by, the tax office	Drawings and dividends (financing)
Income tax or company tax paid by the business	Depreciation (no cash moves; the cash went out under investing when the asset was bought)
Interest paid, in most small business statements	Transfers between your own bank accounts

Interest is the one line that moves: companies reporting under IAS 7 may put it in financing today, and from years beginning on or after 1 January 2027 IFRS 18 moves interest paid there for most of them, which lifts operating cash without changing the bank balance. The IAS 7 statement of cash flows guide shows one company’s figures both ways.

Two things catch owners out:

• VAT and GST. Money collected from customers on behalf of the tax office arrives as cash and leaves a month or a quarter later. A quarter with a large VAT or BAS payment can show weak operating cash even when trading was fine; compare whole quarters or years. The Xero BAS report guide works through how much a quarter’s BAS takes out of the bank.
• Sole traders. A sole trader pays personal income tax on the business’s profit. That is usually coded to drawings in Xero, so it lands under financing, not operating. Take it off before comparing your operating cash flow with a company’s, which has its tax inside the operating section.

Cash flow from operations vs profit, EBITDA and free cash flow

• Net profit counts sales when invoiced and costs when incurred. Operating cash flow counts them when the money moves. Over many years the two track each other; in any one year the gap is mostly debtors, stock, creditors and tax. Profit in Xero but no cash in the bank goes through the usual causes, and the free profit but no cash explainer reconciles your own figures.
• EBITDA adds depreciation back like operating cash flow does, but it ignores the cash tied up in debtors and stock, and it is before tax. For the builder above, EBITDA would be at least £90,000 (profit plus depreciation, before any interest is added back) while operating cash was −£9,000. The operating profit guide explains EBIT and EBITDA, and the EBITDA calculator works out yours.
• Free cash flow is operating cash flow less what was spent on equipment and vehicles. It is the cash left for loan repayments, drawings and dividends. The free cash flow calculator accepts an operating cash flow figure directly and takes the equipment off. Free cash flow is also what a buyer values: discounted cash flow turns five years of it into a value for the business. Valuers add the interest back first (unlevered free cash flow), while the cash the owners can take out is what remains after interest and loan repayments; unlevered vs levered free cash flow works through both with one company.
• Net cash flow is all three sections together: operating, investing and financing. The net cash flow calculator splits a period’s money in and out into those three and says which one moved the bank, and cash inflow and outflow examples shows which payments belong in each. Cash flow from investing and financing activities covers the other two sections, with a landscaping company whose bank balance fell only $2,000 in a year because a $50,000 loan paid for its dividends.

How to get it from Xero

Xero’s Statement of Cash Flows report (under Accounting › Reports) uses the direct method. Its first section is Operating Activities, with lines such as receipts from customers and payments to suppliers and employees, and the total at the bottom of that section is your cash flow from operations for the dates you chose. Menu names and labels move between Xero releases and regions, so if something does not match your screen, search Xero Central for the report name. Before trusting the figure, check that every bank account and card is in Xero and reconciled, and that transfers between your own accounts are not coded as income or costs; Xero Statement of Cash Flows: how to run and read it covers these checks.

To work it out the indirect way, which shows why cash differs from profit:

1. Run the Profit and Loss for the period and note net profit and depreciation.
2. Run the Balance Sheet at the start date and the end date, and note the change in accounts receivable, inventory (if you track stock) and accounts payable.
3. Put them through the formula above, then take off tax paid in the period.

Cash flow statement example works a full year both ways, including the investing and financing sections, and gives a layout you can copy.

Reading your own figure

• Is it positive? One negative month can be timing: a big VAT or BAS payment, an annual insurance bill, a slow customer. Three negative months in a row means trading is not paying for itself, and the cash runway calculator shows how long the bank balance lasts at that rate.
• How does it compare with profit? Over a year, cash conversion of 80% or more is healthy for most service businesses. Well below that, look at debtors first, then stock. Cash conversion ratio works through the before-tax, EBITDA and free cash flow versions with one company’s two years. The cash conversion cycle calculator shows how many days of cash your debtors and stock tie up, less what suppliers fund.
• Does it cover repayments and what the owners take? If loan repayments plus drawings or dividends are bigger than operating cash flow, the difference comes out of the bank. How much can I pay myself? works out an amount the business can sustain.
• Is it improving? Compare the same months year on year, because seasonal businesses swing. A growing business often has weaker operating cash than its profit, because more sales means more invoices outstanding and more stock; that is normal, but it has to be funded.

Common questions

What is cash flow from operations? Cash flow from operations is the cash a business’s normal trading brought in over a period: money received from customers, less money paid to suppliers, staff, landlords and the tax office. It leaves out buying or selling equipment, and loans, owner money, drawings and dividends.

How do you calculate cash flow from operations? Start with net profit before tax, add back depreciation, take off any increase in debtors and stock, add any increase in creditors, then take off tax paid. Or add up cash received from customers and take off cash paid for running costs, interest and tax. Both methods give the same figure.

Is operating cash flow the same as cash flow from operations? Yes. Operating cash flow, cash flow from operations, cash from operating activities and net cash from operating activities all mean the same thing. Some statements also show a subtotal called cash generated from operations, which is the figure before tax paid.

Why is my cash flow from operations lower than my profit? Usually because customers owe more than they did at the start of the period, stock has built up, suppliers were paid faster, or a large tax bill from an earlier period was paid. Each of these uses cash without reducing profit.

Can a profitable business have negative operating cash flow? Yes. A business that grows fast, invoices large jobs near the end of a period or builds stock ahead of a busy season can show a profit while its trading uses cash. It is a warning sign if it lasts, because the gap has to be paid for by the bank balance, a loan or the owners.

Is operating cash flow the same as EBITDA? No. EBITDA adds depreciation and amortisation back to operating profit, but it ignores money tied up in unpaid invoices and stock, and it is before tax. Operating cash flow includes both, so it is usually the more honest measure of the cash trading produced.

Where is cash flow from operations in Xero? In the Statement of Cash Flows report, under Accounting, Reports. The first section is Operating Activities, and its total is the cash flow from operations for the dates you choose. Check that all bank accounts are in Xero and reconciled before relying on it.

Your cash, explained every Monday

ReportPilot reads your Xero figures and sends a short plain-English email every Monday: the cash in the bank against the end of last month, roughly how many months it lasts if it has been falling, money owed to you that is past due and by whom, and bills due in the next two weeks against your cash. It asks Xero for read-only access, and there is a 14-day free trial with no card.