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 valueEnterprise ValueEnterprise Value is a measure of a company's total value that spans the entire market rather than just the equity value. It includes all debt and equity-based ownership claims. This value, which is calculated as the market value of debt + market value of equity - cash and cash equivalents, is particularly relevant when valuing a takeover., in simple terms, is the current market value of the firm. It identifies the opportunity costOpportunity CostThe difference between the chosen plan of action and the next best plan is known as the opportunity cost. It's essentially the cost of the next best alternative that has been forgiven. 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 operationsCash Flow From OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital. includes cash from primary business operations of the company.
- 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. The lower the ratio, the 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, let’s 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.
- Cash returns on asset ratio is an essential 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 statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. to a great extent.
- It is an important metric to identify the investment opportunity and comparing firms operating in similar businesses. In general, a higher ratio is better when analyzing the capital intensiveCapital IntensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining. firms like automakers or real estate firms.
- Last but the most crucial 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 sheetThe Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.
- 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 critical metric in analyzing the financial status of the firm. It provides a snapshot of how much time a firm will take to repay all its debt using its operating activitiesOperating ActivitiesOperating activities generate the majority of the company's cash flows since they are directly linked to the company's core business activities such as sales, distribution, and production.—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.
The Capital ExpenditureCapital ExpenditureCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year. Ratio Formula is represented as follows,
- Capital spent by management on building long term assets of the firm;
- The capital expenditure ratio is an essential 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 crucial 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 the 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.
This article 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 –