What the Different Types of Cash Flow Ratios Can Tell You

Introduction

Cash flow ratios are an integral tool used to analyze the money that flows in and out of a business. By properly assessing the liquidity and solvency of a business, they enable a comprehensive assessment of the fiscal health of the company. They can also be used to make forecasts regarding the company’s future performance. There are several different types of cash flow ratios that each have their own unique identifier. Let’s take a look at a few of the most important cash flow ratios and see what they can tell us.

Operating Cash Flow

Operating cash flow measures the amount of money a business has left over after deducting operating expenses like rent, utilities, labor, and other costs.

Definition

Operating Cash Flow is the difference between a company's income or revenues, and its expenses. It is a measure of the cash that a company has generated from its normal operations. It is a great indicator of a company's ability to generate cash to meet its current obligations and use for investments and future growth. Operating Cash Flow is an important indicator of the health of a company's operations.

Ratios

There are several ratios that can be calculated to help analyze a company's operating cash flow. These ratios can provide insight into a company's financial health, profitability, and liquidity. Some of the more commonly used ratios include:

• Operating Cash Flow per Share: This measures the operating cash flow generated by each share of the company's stock.
• Gross Cash Flow Margin: This ratio measures the gross margin of the operating cash flow after deducting all costs related to the operating activities.
• Cash Flow per Share: This ratio measures how much operating cash flow is generated for each share of the company's stock.
• Net Operating Cash Flow: This is a measure of the cash generated after deducting all of the company's operating expenses.

These ratios can provide insight into the company's ability to generate income from its operations. They can also be useful in analyzing the company's liquidity and its ability to meet upcoming obligations.

Cash Flow from Investing

Cash flow from investing is the net cash outflow or inflow of a company’s acquisitions, divestitures, and capital expenditure activities. It refers to the amount of money that is used to purchase fixed assets and investments. If a company has a net outflow of cash, it means that it invested more than it made from any divestitures. If the company has a net inflow, it means that it made more from divestiture activities than it invested in capital purchases.

Definition

Cash flow from investing is the net difference between a company’s capital expenditure and any divestment activities. When a company is looking to acquire new fixed assets or investments, the capital expenditure activities are recorded as an inflow of cash. Any money made from divestment activities is recorded as an outflow of cash. The difference between these two is the cash flow from investing.

Ratios

Cash flow from investing can be used to calculate various ratios. The main cash flow from investing ratios include cash flow to debt, cash flow to sales and cash flow to capital expenditure. The cash flow to debt ratio measures the amount of cash that a company generates, relative to its debt obligations. The cash flow to sales ratio measures the cash generated from sales against the operating and capital expenditures. Lastly, the cash flow to capital expenditure ratio is a measure of the cash a company generates, relative to its capital expenditure.

Understanding cash flow from investing ratios can provide insight into a company’s capital and acquisition activities. Companies whose cash flow from investing ratios are higher than the industry average may be viewed as more financially secure, as they are able to generate more cash than they expend.

Cash Flow from Financing

Cash flow from financing activities describes the company’s borrowing and debt-repayment activities during the period. It is defined as the net cash flow due to activities that result in changes in the size of the company's capital structure. We can use various ratios to measure the inflow and outflow of funds, which can help us understand the efficiency of the company’s debt and equity financing activities.

Ratios

The following ratios measure the cash flow from financing activities:

• Debt-to-equity ratio: This ratio provides an indication of the company's financial risk by showing the proportion of shareholders’ equity and debt used to finance the business.
• Debt-service coverage ratio: This ratio measures the ability of a company to generate enough cash flow to cover its debt service obligations (i.e., interest payments and principal payments).
• Cash flow to debt ratio: This ratio measures the proportion of cash flow to the company's total debt.
• Debt-paydown ratio: This ratio measures the proportion of the debt that is repaid over the course of one year.

These ratios give us an insight into the company’s ability to meet its financial obligations. An analysis of these ratios can help us determine if the company is able to manage its debt and other financing activities efficiently.

Free Cash Flow

Free Cash Flow (FCF) is a measure of a company’s financial performance and is used to evaluate the firm’s ability to generate cash. It is calculated by subtracting capital expenditures from operating cash flow and is expressed as a net figure. The free cash flow figure is commonly used to assess a company’s ability to pay dividends, expand operations, repay debt, etc. Investors can use FCF to gauge a company’s underlying economic performance and financial health.

Definition

The free cash flow is defined as the cash that a company has left to use from its operations, after subtracting out, investment spending and debt payments. FCF is calculated as operating cash flow minus capital expenditure. Operating cash flow is defined as the cash flow that is generated from the company’s day-to-day operations, while capital expenditure is defined as the cash outlay used to acquire, develop or maintain fixed assets. The FCF calculation can give an indication of how much cash a company has left to use in a given period.

Ratios

In addition to calculating the free cash flow, investors may want to assess the company’s ability to generate cash as a percentage of sales or other metrics. The following ratios measure a company’s cash generation ability:

• Free Cash Flow to Sales Ratio: This ratio measures the company’s free cash flow as a percentage of total sales. It helps investors get a better idea of how efficiently the company is generating cash from its operations.
• Free Cash Flow Yield: This ratio measures the free cash flow generated by the company in relation to its market capitalization (the value of the company itself). It helps investors compare the company’s performance to its peers.
• Free Cash Flow to Assets Ratio: This ratio measures the company’s free cash flow as a percentage of total assets. It shows the company’s ability to generate cash return on its assets.

Cash Flow Ratio Analysis

Cash flow ratios are used to measure liquidity and financial health. It allows you to understand how quickly a business is able to generate cash and how effectively it is allocating resources. Cash flow ratios can also give insight into a company’s ability to pay its debts and expand in the future.

Interpretation of Ratios

The main cash flow ratios are cash flow from operations, cash flow from investing and cash flow from financing. Cash flow from operations looks at the company’s total cash generated from normal operational activities, such as sales of goods and services. Cash flow from investing looks at cash generated from investments, such as stock or bond purchases. Cash flow from financing looks at cash generated from borrowed funds, such as loans and dividends.

Cash flow ratios can also be used to measure a company’s ability to pay its debts in a timely manner. For example, the debt to equity ratio and the current ratio measure a company’s leverage and liquidity, respectively. A high debt to equity ratio indicates higher leverage, while a high current ratio indicates higher liquidity.

Key Takeaways

• Cash flow ratios measure liquidity and financial health and can provide insight into a company’s ability to pay its debts and expand in the future.
• The main cash flow ratios are cash flow from operations, cash flow from investing and cash flow from financing.
• Cash flow ratios can also be used to measure a company’s ability to pay its debts in a timely manner.

Conclusion

Cash flow ratio analysis can help businesses to gain insight into their financial performance. There are four main types of cash flow ratios: liquidity, solvency, profitability and efficiency. Liquidity ratios show a business’ ability to pay short-term liabilities. Solvency ratios measure the extent to which a company can cover its long-term obligations. Profitability ratios measure how well a business can generate return on assets and shareholder equity. Efficiency ratios show how well a business utilizes its assets. Each of these types of ratios help businesses to gain useful insight into their overall financial health.

It is important to remember that individual ratios alone are not enough to tell the full financial story. Ratios should be looked at together as part of an overall analysis. By using multiple cash flow ratios, investors and potential lenders can get a more comprehensive picture of the business and its financial performance.

With careful cash flow ratio analysis, businesses can make more informed decisions about their finances, ensuring that their financial goals can be met in the most effective and efficient way possible.