What are the common cash flow ratios and how can you use them effectively?

1 Operating Cash Flow Ratio

The operating cash flow ratio measures how well a business can cover its current liabilities with the cash generated from its core operations. It is calculated by dividing the operating cash flow by the current liabilities. A higher ratio indicates that the business has more cash available to pay its short-term debts, invest in growth opportunities, or distribute to shareholders. A lower ratio suggests that the business may struggle to meet its obligations or rely on external financing. The operating cash flow ratio can vary depending on the industry, business model, and seasonality, so it is important to compare it with the historical trends and the industry benchmarks.

2 Free Cash Flow Ratio

The free cash flow ratio measures how much cash a business can generate after deducting the capital expenditures needed to maintain or expand its assets. It is calculated by dividing the free cash flow by the operating cash flow. A higher ratio indicates that the business has more cash left over after investing in its long-term assets, which can be used for debt repayment, acquisitions, dividends, or share buybacks. A lower ratio suggests that the business has to spend a large portion of its operating cash flow on capital expenditures, which can limit its financial flexibility and growth potential. The free cash flow ratio can help investors and creditors assess the quality and sustainability of the cash flow and the valuation of the business.

3 Cash Flow Coverage Ratio

The cash flow coverage ratio measures how many times a business can cover its interest and principal payments with its operating cash flow. It is calculated by dividing the operating cash flow by the total debt service, which is the sum of the interest and principal payments due within a year. A higher ratio indicates that the business has more than enough cash to service its debt obligations, which reduces the risk of default and improves the creditworthiness. A lower ratio suggests that the business may have difficulty paying its debt or need to refinance or restructure its debt. The cash flow coverage ratio can help lenders and bondholders evaluate the solvency and liquidity of the business and the likelihood of repayment.

4 Cash Flow Margin Ratio

The cash flow margin ratio measures how much cash a business generates from its sales. It is calculated by dividing the operating cash flow by the net sales. A higher ratio indicates that the business has a high cash conversion efficiency, which means that it can turn its sales into cash quickly and effectively. A lower ratio suggests that the business has a low cash conversion efficiency, which means that it may have issues with its inventory management, accounts receivable collection, or expense control. The cash flow margin ratio can help managers and shareholders monitor the profitability and operational efficiency of the business and identify areas for improvement.

5 Cash Return on Assets Ratio

The cash return on assets ratio measures how well a business uses its assets to generate cash. It is calculated by dividing the operating cash flow by the average total assets. A higher ratio indicates that the business has a high cash productivity, which means that it can generate more cash with less assets. A lower ratio suggests that the business has a low cash productivity, which means that it may have excess or underutilized assets. The cash return on assets ratio can help investors and analysts compare the performance and value of different businesses and industries, as it eliminates the effects of depreciation, amortization, and accounting policies.

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?