Cash Flow Ratios
Cash flow ratios are financial metrics used to assess a company’s liquidity, solvency, and overall financial health by analyzing the cash flows generated from its operations, investing, and financing activities. These ratios help investors and analysts understand how well a company manages its cash resources, its ability to meet its short-term and long-term obligations, and its capacity to generate returns for shareholders. Some common cash flow ratios include:
- Operating Cash Flow Ratio: Measures the ability of a company to cover its current liabilities with cash generated from its operations. A higher ratio indicates better short-term liquidity.
- Formula: Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities
- Free Cash Flow to Operating Cash Flow Ratio: Compares a company’s free cash flow (cash generated from operations minus capital expenditures) with its operating cash flow. A higher ratio suggests a company has more cash available to fund growth, pay dividends, or reduce debt.
- Formula: Free Cash Flow to Operating Cash Flow Ratio = Free Cash Flow / Operating Cash Flow
- Cash Flow Coverage Ratio: Evaluates a company’s ability to meet its debt obligations using its operating cash flow. A higher ratio indicates that the company has a better capacity to service its debt.
- Formula: Cash Flow Coverage Ratio = Operating Cash Flow / Total Debt
- Cash Flow Return on Investment (CFROI): Measures the cash return generated by a company on its invested capital. A higher ratio signifies better efficiency in utilizing invested capital to generate returns.
- Formula: CFROI = Cash Flow from Operations / (Total Assets – Current Liabilities)
- Price to Cash Flow Ratio: Compares a company’s market price per share to its cash flow per share. This ratio helps investors evaluate the relative value of a company based on its cash generation ability.
- Formula: Price to Cash Flow Ratio = Market Price per Share / Cash Flow per Share
These cash flow ratios, along with other financial metrics, provide insights into a company’s financial performance and health. It’s essential to analyze these ratios in the context of industry norms and historical trends to make informed decisions.
Example of Cash Flow Ratios
Let’s consider a hypothetical example of a company called TechCo, and we will calculate some of its cash flow ratios based on the following financial data:
Operating Cash Flow (OCF): $800,000
Current Liabilities: $400,000
Total Debt: $1,000,000
Capital Expenditures (CAPEX): $200,000
Total Assets: $2,500,000
Market Price per Share: $40
Weighted Average Number of Shares Outstanding: 100,000
Now, let’s calculate some cash flow ratios for TechCo:
- Operating Cash Flow Ratio:
Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities
= $800,000 / $400,000
= 2.0 - Free Cash Flow to Operating Cash Flow Ratio:
Free Cash Flow = Operating Cash Flow – Capital Expenditures
= $800,000 – $200,000
= $600,000
Free Cash Flow to Operating Cash Flow Ratio = Free Cash Flow / Operating Cash Flow
= $600,000 / $800,000
= 0.75 - Cash Flow Coverage Ratio:
Cash Flow Coverage Ratio = Operating Cash Flow / Total Debt
= $800,000 / $1,000,000
= 0.8 - Cash Flow Return on Investment (CFROI):
CFROI = Cash Flow from Operations / (Total Assets – Current Liabilities)
= $800,000 / ($2,500,000 – $400,000)
= $800,000 / $2,100,000
= 0.381 - Price to Cash Flow Ratio:
Cash Flow per Share = Operating Cash Flow / Weighted Average Number of Shares Outstanding
= $800,000 / 100,000 = $8
Price to Cash Flow Ratio = Market Price per Share / Cash Flow per Share
= $40 / $8
= 5.0
These cash flow ratios provide insights into TechCo’s liquidity, solvency, efficiency, and valuation. For a comprehensive analysis, it’s important to compare these ratios to industry peers and historical trends, as well as to consider other financial metrics and the overall market environment.
