The operating cash flow (NOF) is an indicator that serves to identify the cash investment and immediate liquidity required by a given company to meet its operating expenses and develop its activity.
In a company, the product development process implies that long periods of time may elapse from the time raw materials or materials are purchased (payment to suppliers) to the time the final product is produced, and until it is charged to the customer.
The calculation of the operating cash flow needs (cash on hand) is used to determine the money needed to continue with the activity during that period in which the company is overdrawn and the collections begin to arrive and the investment is recovered, i.e. a time during which there is a liquidity deficit. It is a basic tool for planning a company's activity in the short term and maintaining its solvency.
NOFs take into account the following assets:
- Inventories: Resources to maintain stock, work-in-process and finished goods, as well as direct purchase of merchandise for sale.
- Credit to customers: This is financing aimed at deferring the collection of invoices from customers.
- Operating cash flow: The money the company has available to cover its daily business expenses.
In order to calculate the NOF, the maturity cycle of the company's product must be taken into account:
- The stock phase: This phase lasts from the time the goods are purchased until they are sold.
- The collection phase: This phase takes place from the time the sale of the goods is agreed upon until the sale is carried out.
NOF is calculated by subtracting current liabilities from current operating assets. The first part is the investment made in working capital and the second part is the financing without cost that comes from suppliers (spontaneous liabilities). The formula, expressed as an equation, would be as follows:
NOF = Inventories + Operating cash + Clients (accounts receivable) - Spontaneous or operating liabilities (accounts payable).
One of the most widely used variants of the NOF is the one used to determine the number of days that each phase of the maturity period lasts. For this purpose, the average duration of the inventory (average stock period or pmp), collection (average collection period or pmc) and payment (average payment period or pmp) phases, expressed in days, is obtained using the following formula:
Average inventory holding period (ASP):
pme = (inventories / cost of sales and production cost) x 365
Average collection period (APP):
pmc = (installment customers / total sales) x 365
Average payment period (pmp):
pmp = (forward suppliers / total purchases) x 365
By substituting in the first formula the values of these operations in days (leaving aside the cash flow) it is possible to calculate the days in which there will be an operational need for funds, from the payment to suppliers to the collection of sales.
Finally, to know the real liquidity availability of a company and its solvency in this period, the NOF should be compared with the Working Capital Fund (WC):
FM = current assets - current liabilities
If the working capital turns out to be less than the NOF, the company has to reinforce its structure with working capital financing.
This situation of lower FM than NOF is usually found in companies with projects in the initial stage, and/or in the growth phase. The use of alternative financing specialized in working capital (Factoring, Confirming, and Treasury Loans) is a very useful resource for companies in this stage.
