What is Cash Flow from Operations Ratio?
Cash Flow from Operations Ratio is the ratio that helps in measuring the adequacy of the cash which are generated by the operating activities that can cover its current liabilities and it is calculated by dividing the cash flows from the operations of the company with its total current liabilities.
#1 – CFO Enterprise Multiple
EV to CFO Formula is represented as follows,
Another more popular and precise formula:
- Enterprise value in simple terms is the current market value of the firm. It identifies the opportunity cost of the business at the current point of time. It is the sum of all assets and liabilities that the firm is entitled to. It’s a very dynamic value and can vary a lot with time.
- It is often confused with the market capitalization of listed companies which only reflects the value of common equity. Because of the comprehensive worth that it provides, enterprise value is often the replacement for total Enterprise value.
- Cash flow from operations includes cash from primary business operations of the company.
Interpretation
- CFO enterprise multiple helps in calculating the number of years the firm will take to buy its entire business using the cash flow generated from the core business activities of the firm. In simple terms, how much time the firm will take to repay all debt and other liabilities by using the operations cash flow without putting any restraint on the assets of the firm. This analysis is helpful in mergers and acquisitions.
- This metric is very helpful for investors comparing firms operating in a similar business. Lower the ratio, more attractive is the firm for investment.
Example of Ev to CFO Formula
Let’s consider a firm with the following financials.
Using the above numbers lets calculate CFO enterprise multiple using the above equations
((10,000,000 * 50) + 500,000 – 300,000) / 50,000,000
EV/CFO = 10.004
#2 – Cash Returns on Asset Ratio
Cash Returns on Asset Formula is represented as follows,
- Total Assets includes all assets and not just limited to the fixed assets and can be calculated directly from the balance sheet.
Interpretation
- Cash returns on asset ratio is an important metric in capital intensive firms. It helps in evaluating the financial condition of the firm which large investments in assets like setting up manufacturing plants and workshops, buying raw materials as these large investments, owing to the large value per transaction, can alter the financial statements to a great extent.
- It is an important metric to identify the investment opportunity and comparing firms operating in similar business. In general, a higher ratio is better when analyzing the capital intensive firms like automakers or real estate firms.
- Last but the most important attribute of this metric is that it helps in identifying how efficiently the firm is employing its assets. A higher value may convince the investors that the firm has good operational efficiency and may continue to grow at a good pace eventually giving better returns to its shareholders.
Example of Cash Returns on Asset Ratio
Let’s consider the example of an automaker with the following financials.
Cash returns on assets = cash flow from operations/ Total assets
= 500,000 $/ 100,000 $
Cash Returns on Asset Ratio = 5
This means that the automaker generates a cash flow of 5$ on every 1$ of assets that it has. Comparing it with other automakers in the economy, an investor can identify how are the growth prospects of the firm.
#3 – Cash Flow to Debt Ratio
Cash Flow to Debt Ratio Formula is represented as follows,
- Total debt calculated from the balance sheet
Interpretation
- Although fairly unrealistic and impractical for the management of a firm to use all its operating cash flows to repay the outstanding debt, cash flow to debt ratio provides a very important metric in analyzing the financial status of the firm. It provides a snapshot of how much time a firm will take in repay all its debt using its operating activities. Hence providing an important instrument in identifying the return on investment for both shareholders and other firms looking to acquire it.
- In addition to identifying the growth opportunities, it also helps the investors in identifying if the firm is highly leveraged or not. This measure can be helpful for risk-averse investors in making investment decisions
Example of Cash Flow to Debt Ratio
Let’s continue with our previous example of the automaker with the following financials.
Using the above formula, cash flow to debt ratio = 500,000/2,000,000
Cash Flow to Debt Ratio = .25 or 25%
#4 – Capital Expenditure Ratio
Often termed as CF to capex ratio, capital expenditure ratio measures a firm’s ability to buy its long term assets using the cash flow generated from the core activities of the business.
Capital Expenditure Ratio Formula is represented as follows,
- Capital spent by management on building long term assets of the firm.
Interpretation
- Capital expenditure ratio is an important metric for fundamental analysts as it helps in finding if the firm is undervalued or overvalued. Rather than used as an individual ratio, it is primarily used to compare similar firms in an economy
- This metric is also important for the management as it helps them in identifying where exactly the cash flows of the firm is going. Knowing this data, management can strategize for future and devote its attention to evaluate capital intensive projects like setting up a new office or expanding a production facility, launching a new set of products or restructuring the operational setup.
Recommended Article
This has been a guide to Cash Flow from Operations Ratio. Here we discuss the top 4 operating cash flow ratios including CFO EV Multiple, Cash returns on assets, Cash flow to debt ratio and more. You may learn more about finance from the following articles –
