advantages and drawbacks of these 3 methods

Method 1: Dollars In Minus Dollars Out Take only the items from the income statement that represent actual cash flows. This means that you start with cash revenues and subtract cash expenses and taxes paid. You do not, however, subtract a charge for depreciation because this does not involve cash going out the door. Thus, Operating cash flow = revenues cash expenses taxes Method 2: Adjusted Accounting Profits Alternatively, you can start with aftertax accounting profits and add back any noncash "accounting expenses," specifically, the depreciation deduction. This gives Operating cash flow = after-tax profit + depreciation Method 3: Add Back Depreciation Tax Shield Although the depreciation deduction is not a cash expense, it does affect the firm's tax payment, which certainly is a cash item. Each additional dollar of depreciation reduces taxable income by $1. So, if the firm's tax bracket is 35%, tax payments fall by $.35, and cash flow increases by the same amount. Financial managers often refer to this tax saving as the depreciation tax shield. It equals the product of the tax rate and the depreciation charge: Depreciation tax shield = tax rate depreciation This suggests a third way to calculate operating cash flow. First, calculate net profit, initially assuming zero depreciation. This is equal to (revenues - cash expenses) (1tax rate ). Now add back the tax shield based on the amount of depreciation actually claimed to find operating cash flow: Operatingcashflow=(revenuescashexpenses)(1taxrate)+(taxratedepreciation) The following example confirms that the three methods all give the same figure for operating cash flow