X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2019 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
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

Is HDFC Mutual Fund Absorbing Losses Out Of Compulsion? (Outside View)

Jun 19, 2019

PersonalFN explains why probably HDFC Mutual Fund decided to bail out its FMPs.

My Upcoming Stock Recommendation, Backed by Aberdeen Standard Investments, Scores 9.1/10 (The 5 Minute Wrapup)

Jun 19, 2019

This month's Smart Money Secrets recommendation is from global super investor - Aberdeen Standard Investments.

How To Check If A Mutual Fund Scheme Is A Consistent Performer Or Not (Outside View)

Jun 19, 2019

PersonalFN explains how you can check consistency of mutual funds to select the right fund.

I've Identified the Winners from the NBFC Crisis with Price Action (Profit Hunter)

Jun 19, 2019

Here's a list of banks and NBFC's which could emerge as winners over the next few years.

Bond Yields Hit New Lows - Should You Worry? (Fast Profits Daily)

Jun 19, 2019

Indian bond yields at 2017 lows. How are you impacted?

More Views on News

Most Popular

7 Stocks That Will Remain Evergreen in this Era of Technological Disruption(The 5 Minute Wrapup)

Jun 13, 2019

We are living in an era of disruption. Are your stocks well equipped to adapt to changes that disruption will bring along?

The Great Indian NBFC Bubble Has Burst but I Will Still Recommend These Safe NBFCs(The 5 Minute Wrapup)

Jun 11, 2019

One chart that predicted the NBFC crisis back in 2016.

Just One Stock Made Buffett Billions - And Can Make You Crores(Profit Hunter)

Jun 6, 2019

Coca Cola is arguably one of Warren Buffet's best stock picks. But did you know that small investors picked up the stock five decades before Buffet? Read on...

Kenneth Andrade Would Like Our Real Estate Stock Recommendation with Triple Digit Upside(The 5 Minute Wrapup)

Jun 12, 2019

This real estate stock recommended in Smart Money Secrets offers the most favourable upside potential.

Why Modi 2.0 Will Be Great for These 7 Stocks(Profit Hunter)

Jun 10, 2019

The government's focus on Infra, electricity, water for all will be the key factors for Sensex 1,00,000.

More

Get the Indian Stock Market's
Most Profitable Ideas

How To Beat Sensex Guide 2019
Get our special report, How to Beat Sensex Nearly 3X Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Jun 19, 2019 (Close)

MARKET STATS