How To Calculate Net Cash After Operations (NCAO)
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One of the components of financial statements is the statement of cash flow. It is responsible for telling users how cash moves in and out of the entity and how the cash is being used in the business. It will also allow users of the financial statements to see if cash is being used efficiently.
Net cash after operations (NCAO) is an important financial metric for businesses. Banks will look at NCAO when underwriting loans and financial analysts will evaluate NCAO when analyzing business performance.
What is Net Cash After Operations?
Net cash after operations focuses on the cash flows that are directly related to the business’s day-to-day operations. It excludes cash flows from investing and financing activities such as dividends paid or received, purchase or disposal of plant assets, interests paid or received, proceeds from or repayments of loans and so on.
How To Calculate Net Cash After Operations
To give a clear picture of how NCAO should be calculated, I will list down the five steps below with an example, Company A, that follows through in all the steps.
Step 1 – Earnings Before Tax
We will first start with the earnings before tax of the entity. Earnings before tax can be obtained from the income statement of the entity. Let’s say the earnings before tax of Company A is $100,000.
Step 2 – Adjustments for Non-Cash Items
Next, we look for non-cash items that need to be added back or deducted. Non-cash items refer to income and expenses that do not have underlying actual cash transactions. Examples of non-cash items include depreciation, gain or loss on disposal of plant assets or investments, etc.
Company A has the following non-cash items:
- Depreciation of $10,000 (to add back)
- Loss on disposal of investment $25,000 (to add back)
- Gain on disposal of plant assets of $5,000 (to deduct).
After the non-cash adjustments, we will arrive at $130,000 ($100,000 + $10,000 + $25,000 – $5,000).
Step 3 – Adjustments for Non-Operating Activities
We also need to exclude cash flows related to investing and financing activities that we mentioned above.
In this case, Company A has $10,000 of dividend income. We will then deduct $10,000 from $130,000. The adjusted earnings before tax are now at $120,000.
Step 4 – Adjustment based on Working Capital Movements
We will then add or subtract the movements in working capital. Working capital refers to inventories, receivables and payables.
An increase in both inventories and receivables should be deducted from the cash flow while a decrease should be added back.
For payables, it is the opposite. An increase in payables should be added back whereas, a decrease should be deducted from cash flow.
In Company A’s case, it has:
- Increase in receivables of $20,000 (to deduct)
- Increase in payables of $10,000 (to add back)
After the adjustments, we will have the cash from operations at $110,000 ($120,000 – $20,000 + $10,000).
Step 5 – Adjustments for Tax
To get the final NCAO, we need to further deduct the tax paid and add back the tax refund.
Company A has paid its tax bill of $3,000. With this last adjustment, we will obtain the final NCAO of $107,000 ($110,000 – $3,000).