How do you communicate the implications of OCF ratio and FCF ratio to your stakeholders or clients?

1 OCF ratio

The OCF ratio is the ratio of operating cash flow to current liabilities. Operating cash flow is the cash generated from the core business activities of a company, such as selling products or services, paying suppliers, and managing inventory. Current liabilities are the debts and obligations that are due within one year, such as accounts payable, short-term loans, and taxes. The OCF ratio tells you how well a company can cover its short-term obligations with its operating cash flow. A higher OCF ratio means a stronger liquidity position and a lower risk of default.

2 FCF ratio

The FCF ratio is the ratio of free cash flow to operating cash flow. Free cash flow is the cash left over after deducting capital expenditures from operating cash flow. Capital expenditures are the cash spent on acquiring or maintaining long-term assets, such as buildings, equipment, and software. The FCF ratio tells you how much of the operating cash flow is available for other purposes, such as paying dividends, repaying debt, or investing in growth opportunities. A higher FCF ratio means a greater cash flow flexibility and a higher potential for value creation.

3 Comparing OCF and FCF ratios

Both OCF and FCF ratios can provide useful insights into the cash flow performance of a company, but they have different focuses and limitations. The OCF ratio focuses on the short-term liquidity and solvency of a company, while the FCF ratio focuses on the long-term profitability and sustainability of a company. The OCF ratio does not account for the cash needed to maintain or expand the productive capacity of a company, while the FCF ratio does not account for the cash needed to meet the current obligations of a company. Therefore, it is important to compare both ratios and understand the trade-offs between them.

4 Calculating OCF and FCF ratios

To calculate the OCF ratio, you need to divide the operating cash flow by the current liabilities. You can find both numbers in the cash flow statement and the balance sheet of a company. For example, if a company has an operating cash flow of $100,000 and a current liabilities of $50,000, its OCF ratio is 100,000 / 50,000 = 2. This means that the company can cover its current liabilities twice with its operating cash flow.

To calculate the FCF ratio, you need to divide the free cash flow by the operating cash flow. You can find the operating cash flow in the cash flow statement and the capital expenditures in the cash flow statement or the income statement of a company. To get the free cash flow, you need to subtract the capital expenditures from the operating cash flow. For example, if a company has an operating cash flow of $100,000 and a capital expenditures of $20,000, its free cash flow is 100,000 - 20,000 = 80,000 and its FCF ratio is 80,000 / 100,000 = 0.8. This means that the company can retain 80% of its operating cash flow for other purposes.

5 Communicating OCF and FCF ratios

When you communicate the OCF and FCF ratios to your stakeholders or clients, you need to explain what they mean, how they are calculated, and how they compare to the industry benchmarks or the historical trends. You also need to highlight the strengths and weaknesses of the cash flow performance of a company and provide recommendations for improvement or action. For example, you can say:

"The OCF ratio of 2 indicates that the company has a strong liquidity position and can easily meet its short-term obligations with its operating cash flow. However, the FCF ratio of 0.8 indicates that the company has a low cash flow flexibility and invests a large portion of its operating cash flow in capital expenditures. This may limit its ability to pay dividends, repay debt, or pursue growth opportunities. Compared to the industry average of 1.5 for OCF ratio and 0.6 for FCF ratio, the company has a higher liquidity but a lower profitability than its peers. To improve its cash flow performance, the company may consider reducing its capital expenditures, increasing its operating efficiency, or diversifying its revenue streams."

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?