Key ratios related to the cashflow statement - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Key ratios related to the cashflow statement

Dec 16, 2009

In the previous article of this series, we had taken a look at one of the components of cash flow statement - cash flow from financing activities. In this article, we shall discuss some of the key ratios relating to the cash flow statement. It is very common that investors give more focus and attention to balance sheets and profit and loss statements. More often than not, novice investors may ignore a company's cash flow statement on account of its relatively complex nature. This is true, when compared to the other two financial statements - balance sheet and profit and loss account.

In the last few articles, we have tried to educate readers about the basics of a cash flow statement. Since we have completed our discussion about some of the technical terms that are found in the cash flow statement, we shall discuss some of the key ratios associated with it.

A cash flow statement is probably the most useful too for judging or testing a company's liquidity position. In addition, it can also help in testing a company's financial health.

We are not implying that the ratios which we discussed earlier related to the other two statements are not useful. All ratios have different usages in terms of testing a company's financial performance.

Free cash flow per share (FCF/ Share): Free Cash Flow (FCF) is the cash earned by the company that can be actually distributed to the shareholders. It signals a company's ability to repay debt, pay dividends and buy back stock - all important undertakings from an investor's point of view.

FCF takes into account not only the earnings of the company but also the past (depreciation) and present capital expenditures and investment in working capital. Growing free cash flows are frequently a prelude to increased earnings. Companies that experience surging FCF due to revenue growth, efficiency improvements, cost reductions can reward investors in the future. Better free cash flows are therefore a reason for the investment community to cherish.

On the other hand, an insufficient FCF for earnings growth can force a company to boost its debt levels. Even worse, a company without enough FCF may not have the liquidity to stay in business

An in-depth methodology would be to adjust a company's increase or decrease in net working capital (current assets less current liabilities) to the above figure. Free cash flow increases if the company manages to improve efficiency and consequently reduce the required working capital. This ratio implies the amount of free cash available per share. It is calculated as follows:

FCF = Net Profit + Depreciation - Capital expenditure - Changes in working capital

Therefore, FCF/share = (Net Profit + Depreciation - Capital expenditure - Changes in working capital) \ Shares outstanding

Price to free cash flow (P/FCF) is a valuation method which allows one to compare the FCF generated per share to its share price. The higher the result, the more expensive is the stock.

Operating cash flow ratio (OCF): OCF is calculated by dividing the cash flow from operations by the current liabilities. This ratio helps in knowing how well short term liabilities of a company are covered by the cash flow from operations. Short term liabilities in this case would be current liabilities.

As such, operating cash flow = cash flow from operations / current liabilities

You may have by now guessed that this ratio helps in ascertaining a company's liquidity position. But so are ratios such as the current ratio and the quick ratio, you may ask. The OCF ratio helps in assessing whether a company's operating cash flow generations are enough to cover its current liabilities. If the ratio falls below 1.0, it means that the company is not generating enough cash to meet its short term liabilities. In order to judge whether a company's OCF is out of line, one should look at comparable ratios for the company's industry peers.

Capital expenditure ratio: This ratio helps in ascertaining how much operating cash flow a company generates as compared to the capital expenditure it incurs. It would always be better to look at the numbers for a particular period as compared to a single or particular year.

It is calculated by dividing the cash flow from operations by the capital expenditure. Therefore:

Capital expenditure ratio = cash flow from operations / capital expenditure

This ratio measures the capital available for internal reinvestment and for payments on existing debt. If the ratio exceeds 1.0, it indicates that the company has enough funds to meet its capex requirements. As such, higher the value, the more spare cash the company has to service and repay debt. One will usually find lower ratios in fast growing companies on the back of high capital investments.

Investing: Back to Basics Article Series - Previous article | Investing: Back to Basics Article Series | Next article

Equitymaster requests your view! Post a comment on "Key ratios related to the cashflow statement". Click here!

  

More Views on News

The Best Stocks in a Volatile Market podcast (Views On News)

Mar 5, 2021

Rahul Shah on the qualities that make for a good investment in an up and down market.

A New Super Cycle in Metals? (Fast Profits Daily)

Mar 5, 2021

In this video, I'll tell you if there is huge money to be made in metals or if there is more to the super cycle story.

Mirae Asset Corporate Bond Fund: Aiming for Growth with Focus on Quality and Liquidity (Outside View)

Mar 5, 2021

PersonalFN analyses the features of Mirae Asset Corporate Bond Fund and explains the potential this fund has to offer to its investors.

Charge Your Portfolio with this Smallcap Proxy Play on India's EV Revolution (Profit Hunter)

Mar 5, 2021

This could be the biggest wealth creator of the decade.

Inflation & Your Investments (Fast Profits Daily)

Mar 4, 2021

Inflation is the buzz word in the world of finance these days. It impacts all of us. Here's how it affects your investments.

More Views on News

Most Popular

How to Find Undervalued Stocks

A short guide on identifying and investing in the most undervalued stocks in India.

It's the Beginning of a New Bull Phase in Smallcaps (Profit Hunter)

Feb 24, 2021

Last time the smallcap index crossed 19k a big correction followed. Here's what makes it different this time.

Make Rs 5,000 Per Day Trading the Market (Fast Profits Daily)

Feb 25, 2021

In this video, I'll show you how to get started on the path to daily trading profits.

The Hidden Tesla in My Great Indian Wealth Project (Profit Hunter)

Feb 23, 2021

An Indian company founded three decades ago in a garage caught my attention...

Gold 65,000 and Silver 84,000 in 2022

Feb 26, 2021

In this episode of the Investor Hour, India's #1 trader, Vijay Bhambwani, talks to us about the stock market, his new targets for gold and silver, the best long-term investment opportunity, and a lot more.

More

India's #1 Trader
Reveals His Secrets

Secret To Increasing Your Trading Profits Today
Get this Special Report,
The Secret to Increasing Your Trading Profits Today, Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Mar 5, 2021 (Close)

MARKET STATS