A liquidity ratio that measures a company's ability to pay off its current liabilities with its cash flow
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What is the Operating Cash Flow Ratio?
The Operating Cash Flow Ratio, a liquidity ratio, is a measure of how well a company can pay off its current liabilities with the cash flow generated from its core business operations. This financial metric shows how much a company earns from its operating activities, per dollar of current liabilities. Since earnings involve accruals and can be manipulated by management, the operating cash flow ratio is considered a very helpful gauge of a company’s short-term liquidity.
Formula
The formula for calculating the operating cash flow ratio is as follows:
Where:
- Cash flow from operations can be found on a company’s statement of cash flows. Alternatively, the formula for cash flow from operations is equal to net income + non-cash expenses + changes in working capital.
- Current liabilities are obligations due within one year. Examples include short-term debt, accounts payable, and accrued liabilities.
What is Cash Flow From Operations?
It is important to understand cash flow from operations (also called operating cash flow) – the numerator of the operating cash flow ratio.
Operating cash flow (OCF) is one of the most important numbers in a company’s accounts. It reflects the amount of cash that a business produces solely from its core business operations. Operating cash flow is intensely scrutinized by investors, as it provides vital information about the health and value of a company. If a company fails to achieve a positive OCF, the company cannot remain solvent in the long term. A negative OCF indicates that a company is not generating sufficient revenues from its core business operations, and therefore needs to generate additional positive cash flow from either financing or investment activities.
Example of the Operating Cash Flow Ratio
The following information was taken out of Company A’s Q2 financial statements:
To calculate the ratio at the end of the second quarter:
Therefore, the company earns $1.25 from operating activities, per dollar of current liabilities. Alternatively, it can be viewed as, “Company A can cover its current liabilities 1.25x over.”
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Interpretation of Operating Cash Flow Ratio
If the ratio is less than 1, the company generated less cash from operations than is needed to pay off its short-term liabilities. This signals short-term problems and a need for more capital. A higher ratio – greater than 1.0 – is preferred by investors, creditors, and analysts, as it means a company can cover its current short-term liabilities and still have earnings left over. Companies with a high or uptrending operating cash flow are generally considered to be in good financial health.
Key Takeaways
- The operating cash flow ratio is a liquidity ratio that measures how well a company can pay off its current liabilities with cash generated from its core business operations.
- This liquidity ratio is considered an accurate measure of short-term liquidity, as it only uses cash generated from core business operations rather than from all income sources.
- A ratio less than 1 indicates short-term cash flow problems; a ratio greater than 1 indicates good financial health, as it indicates cash flow more than sufficient to meet short-term financial obligations.
Learn More
We hope you have enjoyed reading CFI’s guide to the operating cash flow ratio. To learn more about cash flow and financial analysis, we suggest the following CFI resources:
FAQs
Key Takeaways
What's a good operating cash flow ratio? ›
The operating cash flow ratio represents a company's ability to pay its debts with its existing cash flows. It is determined by dividing operating cash flow by current liabilities. A ratio greater than 1.0 indicates that a company is in a strong position to pay its debts without incurring additional liabilities.
What ratios can be calculated from the cash flow statement? ›
There are six cash flow ratios, namely:
- Current liability coverage ratio. The current liability coverage ratio calculates how much cash you have to pay off debt and measures your liquidity. ...
- Cash flow coverage ratio. ...
- Price-to-cash-flow ratio. ...
- Cash interest coverage ratio. ...
- Operating cash flow ratio. ...
- Cash flow to net income.
A good price-to-cash-flow ratio is any number below 10. Lower ratios show that a stock is undervalued when compared to its cash flows, meaning there is a better value in the stock.
What is the CFO pat ratio formula? ›
This ratio is otherwise known as quality of earnings ratio. It is computed by dividing CFO by Profit After Tax (PAT or Net Income) of a firm. If CFO exceeds the net income, then it is considered the firm can convert its accounting (accrual) earnings into cash. Else, the firm has poor cash flow management practices.
What is considered a good operating ratio? ›
Good operating expense ratios range between 60% and 80%. The lower the operating expense ratio, the better an investment it is.
Is higher operating cash flow better? ›
A higher ratio – greater than 1.0 – is preferred by investors, creditors, and analysts, as it means a company can cover its current short-term liabilities and still have earnings left over. Companies with a high or uptrending operating cash flow are generally considered to be in good financial health.
What does operating cash flow tell you? ›
Key Highlights. Operating cash flow (OCF) is how much cash a company generated (or consumed) from its operating activities during a period. The OCF calculation will always include the following three components: 1) net income, 2) plus non-cash expenses, and 3) minus the net increase in net working capital.
What is a good operating cash flow margin? ›
What is a good operating cash flow margin? A good operating cash flow margin is typically above 50%. If a company has an operating cash flow margin of below 50%, this suggests that the company is not efficiently making sales into cash, and instead, may have high expenses.
What ratio is good for cash flow? ›
Operating cash flow ratio
This ratio calculates how much cash a business makes from its sales. A preferred operating cash flow number is greater than one because it means a business is doing well and the company has enough money to operate.
As of today (2024-09-03), Apple's share price is $229.00. Apple's Free Cash Flow per Share for the trailing twelve months (TTM) ended in Jun. 2024 was $6.73. Hence, Apple's Price-to-Free-Cash-Flow Ratio for today is 34.05.
What is a reasonable cash flow coverage ratio? ›
In most industries, the example above would be a prime example of a good cash flow coverage ratio. Generally, businesses aim for a minimum of 1.5 to comfortably pay debt with operating cash flows.
What is a healthy operating profit ratio? ›
Generally, a 10% operating profit margin is considered an average performance, and a 20% margin is excellent. It's also important to pay attention to the level of interest payments from a company's debt.
What is a good CFO ratio? ›
Generally, a ratio over 1 is considered to be desirable, while a ratio lower than that indicates strained financial standing of the firm.
What is the operating cash flow ratio? ›
The operating cash flow ratio is a measure of the number of times a company can pay off current debts with cash generated within the same period. A high number, greater than one, indicates that a company has generated more cash in a period than what is needed to pay off its current liabilities.
What is the difference between Pat and EBITDA? ›
EBITDA refers to the profit at the operating level, while PAT, i.e. profit after tax, indicates the final profit of the company. EBITDA only takes into account operating expenses, while PAT is calculated after deducting all expenses, financing costs, depreciation, amortisation and taxes.
What is a good operating cash flow yield? ›
Free Cash Flow Yield determines if the stock price provides good value for the amount of free cash flow being generated. In general, especially when researching dividend stocks, yields above 4% would be acceptable for further research. Yields above 7% would be considered of high rank.
What is ideal operating cash flow margin? ›
Well, while there's no one-size-fits-all ratio that your business should be aiming for – mainly because there are significant variations between industries – a higher cash flow margin is usually better. A cash flow margin ratio of 60% is very good, indicating that Company A has a high level of profitability.
What is the operating ideal ratio? ›
Operating ratio values
Operating ratio over one: An operating ratio larger than one shows the company is losing money. Operating ratio below one: An operating ratio smaller than one shows a profit, and a decreasing operating ratio can show that the company is becoming more efficient.
What is a healthy cash flow coverage ratio? ›
The greater the coverage ratio is over 1.2, the better a company's ability to meet its obligations along with having sufficient cash flow to expand its business, participate in the long-term reinvestment strategy, withstand commodity pressures and not be burdened with debt over the long term.
