The value of a firm or a share of a firm’s stock comes down to one simple but profound concept – the time value of cash flows. Specifically, the value of a firm’s stock is determined by the cash that the firm’s investors believe the current management or some future acquirer will be able to produce with the firm’s assets.
That's what makes cash flow ratios so crucial to business operators and investors alike; cash flow ratios provide a consistent methodology for benchmarking and analyzing trends in the sustainability of operations. No business can operate at negative cash flow indefinitely -- though in recent years some high flyers have certainly tested the limits.
In this post, I discuss the ten cash flow ratios that allow investors to accurately determine a business’s true profitability, competitive strength, and credit health. Cash flow ratios vary by sector. For each cash flow ratio, I provide a table listing the median ratio of firms in the finbox.io database by sector. The sector medians are as of November 8th, 2017. You may be interested in my similar posts on Valuation Ratios, Credit Ratios, and Profit & Return Ratios.
Do you want example calculations of the ratios discussed below? I’ve created a spreadsheet template you can use to calculate these ten cash flow ratios yourself. The spreadsheet has three tabs:
- Cheat Sheet: This tab lists Cash Flow ratios and formulas used to calculate each ratio.
- [Linked] Calculator: This tab has formulas that are powered by finbox.io's Spreadsheet add-on so you can use it to automatically fetch data for supported public companies by simply changing the ticker symbol in the designated cell.
- [Example] Calculator: You can use this tab calculate all the ratios discussed for any business by manually entering the financials required in designated cells colored in yellow under the "Required Data" section.
You can make a copy of the Google Spreadsheet by clicking File > Make a copy from the menu or by using the link below:
[ Copy Google Spreadsheet Template ]
[ Download Excel Spreadsheet Template ]
1. Cash Return on Invested Capital (CROIC)
Cash Return on Invested Capital (CROIC) or Cash Return on Capital Invested (CROCI) measures the amount of free cash flow a firm generates on each dollar of capital invested (debt + equity). Since a firm can use its free cash flow to either reinvest in growth or pay shareholders, a high CROIC allows a firm to potentially do both.
Formula
Free Cash Flow = Cash from Operations + Cash from Investing
Invested Capital = Total Debt + Total Equity
CROIC = Free Cash Flow ÷ Average Invested Capital
| Sector | Cash Return On Invested Capital (CROIC) |
|---|---|
| Consumer Discretionary | 5.2% |
| Consumer Staples | 4.2% |
| Energy | 0.0% |
| Financials | NM |
| Healthcare | -18.1% |
| Industrials | 4.4% |
| Information Technology | 2.1% |
| Materials | 2.6% |
| Telecom | 2.7% |
| Utilities | -1.0% |
2. Free Cash Flow to Operating Cash Flow (FCF / OCF)
FCF / OCF measures the amount of free cash flows (FCF) for each dollar of operating cash flows (OCF). A high FCF to OCF ratio suggests that the firm generates enough cash flow to be able to distribute it to capital providers without negatively impacting growth or acquisition plans.
Formula
Free Cash Flow = Cash from Operations + Cash from Investing
FCF / OCF = Free Cash Flow ÷ Cash from Operations
| Sector | FCF / OCF |
|---|---|
| Consumer Discretionary | 56.1% |
| Consumer Staples | 50.2% |
| Energy | 41.3% |
| Financials | NM |
| Healthcare | 88.0% |
| Industrials | 53.2% |
| Information Technology | 61.3% |
| Materials | 47.6% |
| Telecom | 23.9% |
| Utilities | -3.3% |
Cash Flow Margin measures the amount of revenue a firm can convert into operating cash flow. When a firm is thriving, operating cash flow should grow alongside revenue. While profit margins measure a firm's pricing power; a declining cash flow margin also measures the health of customer and supplier relationships. For example, if some firm compromises on receivables terms with customers to boost revenue or payables to suppliers, it will need to invest more in working capital. This dynamic will not reduce profit margins but will, however, reduce cash flow margins.
Formula
Cash Flow Margin = Cash from Operations ÷ Sales
| Sector | Operating Cash Flow Margin |
|---|---|
| Consumer Discretionary | 8.8% |
| Consumer Staples | 8.5% |
| Energy | 18.9% |
| Financials | 25.0% |
| Healthcare | -12.5% |
| Industrials | 8.4% |
| Information Technology | 9.3% |
| Materials | 11.8% |
| Telecom | 24.3% |
| Utilities | 24.6% |
The Asset Efficiency ratio is similar to the Asset Turnover ratio.While the Asset Turnover ratio measures the dollars in sales that a firm can generate from its assets; the Asset Efficiency ratio measures the amount of cash flow that a company generates from its assets.
Formula
Asset Efficiency = Cash from Operations ÷ Average Total Assets
| Sector | Asset Efficiency |
|---|---|
| Consumer Discretionary | 8.4% |
| Consumer Staples | 9.1% |
| Energy | 6.6% |
| Financials | 1.5% |
| Healthcare | -20.3% |
| Industrials | 8.1% |
| Information Technology | 7.3% |
| Materials | 7.7% |
| Telecom | 9.7% |
| Utilities | 6.4% |
Short-Term Debt Coverage measures the amount of cash flow a firm generates for each dollar of short-term debt it uses. Even the fastest growing firms can experience financial stress if they don't generate the cash flow required to pay off short-term debt.
Formula
Short-Term Debt Coverage = Cash from Operations ÷ Short-Term Debt
| Sector | ST Debt Coverage Ratio |
|---|---|
| Consumer Discretionary | 5.0x |
| Consumer Staples | 4.0x |
| Energy | 2.3x |
| Financials | NM |
| Healthcare | 0.2x |
| Industrials | 3.7x |
| Information Technology | 2.5x |
| Materials | 4.1x |
| Telecom | 4.5x |
| Utilities | 1.7x |
CapEx Coverage measures the amount a company outlays for capital assets for each dollar of cash dollar it generates from those investments. If capital expenditures are lumpy or cyclical, this ratio may also be computed using three-year average capital expenditures in the numerator.
Formula
CapEx Coverage = Cash from Operations ÷ Capital Expenditures
| Sector | Capital Expenditures Coverage |
|---|---|
| Consumer Discretionary | 2.3x |
| Consumer Staples | 2.5x |
| Energy | 1.0x |
| Financials | NM |
| Healthcare | -5.2x |
| Industrials | 2.5x |
| Information Technology | 2.8x |
| Materials | 1.8x |
| Telecom | 1.4x |
| Utilities | 0.9x |
Dividend Coverage measures the cash cushion available to management to maintain the firm's dividend to common shareholders. Since cuts in dividend payments are typically not well received by the market, monitoring the dividend coverage ratio for declines can serve as a leading indicator for investors that a cut may be coming on the horizon.
Formula
Dividend Coverage = Cash from Operations ÷ Cash Dividends
| Sector | Dividend Coverage Ratio |
|---|---|
| Consumer Discretionary | 4.6x |
| Consumer Staples | 3.0x |
| Energy | 3.1x |
| Financials | 3.8x |
| Healthcare | 3.8x |
| Industrials | 4.9x |
| Information Technology | 4.1x |
| Materials | 4.5x |
| Telecom | 4.4x |
| Utilities | 3.6x |
8. Cash Flow to Current Liabilities
Cash Flow to Current Liabilities measures the amount of operating cash flow a firm generates on each dollar of current liabilities that it utilizes to finance operations. A low Cash Flow to Current Liabilities indicates that a company is not converting sales into cash flow at a rate that can cover short-term operating liabilities and will likely require external funding to resolve shortfalls.
Formula
Cash Flow to Current Liabilities = Cash from Operations ÷ Average Current Liabilities
| Sector | Cash Flow to Current Liabilities |
|---|---|
| Consumer Discretionary | 45.8% |
| Consumer Staples | 46.3% |
| Energy | 64.7% |
| Financials | 1.9% |
| Healthcare | -105.3% |
| Industrials | 35.9% |
| Information Technology | 30.1% |
| Materials | 51.4% |
| Telecom | 71.5% |
| Utilities | 61.2% |
Cash Flow to Liabilities measures the amount of operating cash flow a firm generates on each dollar of total liabilities. Businesses that can't produce operating cash flow to pay off all their liabilities cannot continue to operate indefinitely, making this ratio an important indicator of liquidity as well as solvency.
Formula
Cash Flow to Liabilities = Cash from Operations ÷ Average Total Liabilities
| Sector | Cash Flow to Liabilities |
|---|---|
| Consumer Discretionary | 13.0% |
| Consumer Staples | 15.2% |
| Energy | 11.8% |
| Financials | 1.7% |
| Healthcare | -45.3% |
| Industrials | 12.8% |
| Information Technology | 15.6% |
| Materials | 13.0% |
| Telecom | 14.6% |
| Utilities | 9.8% |
Dividend Payout Ratio measures the percentage of net income a firm is paying out to shareholders versus retaining for reinvestment in the business. A high or negative payout ratio indicates that the firm's current dividend is unsustainable in the long-term.
Formula
Dividend Payout Ratio = Cash Dividends ÷ Net Income
A high dividend payout ratio can also indicate that management doesn't have “exciting” uses for the cash such as growth, acquisitions, research, and development. This relationship between the dividend payout ratio and growth is defined as follows:
Formula
Retention Ratio = (1 - Dividend Payout Ratio)
Sustainable Growth Rate = Return on Equity x Retention Ratio
The sustainable growth rate is the maximum rate at which a firm can grow without external financing at the current level of profitability and dividend policy. A business that is growing sales faster than its sustainable growth rate it will a) need to increase profitability in the future or b) need to finance the additional growth. If option b) is more likely, management can either reduce the dividend or seek to fund from external sources. Financing from external sources can take the form of debt or equity, but this option adds uncertainty, as the capital market’s environment must be receptive to the management's growth strategy.
| Sector | Payout Ratio |
|---|---|
| Consumer Discretionary | 0.0% |
| Consumer Staples | 18.5% |
| Energy | 0.0% |
| Financials | 28.2% |
| Healthcare | 0.0% |
| Industrials | 0.0% |
| Information Technology | 0.0% |
| Materials | 0.0% |
| Telecom | 14.2% |
| Utilities | 57.3% |
Additional Resources
I’ve created a simple cheat sheet listing the formulas and short descriptions of the ratios discussed for you to download and print for quick reference.
Article by Andy Pai, Finbox.io
