What
are cash flow ratios?
Cash flow ratios
compare cash flows to other elements of the financial statements. A higher cash
flow ratios indicate
a)
higher liquidity
b)
ability to pay divided
c)
ability to service principal debt and
interest
d) ability
to withstand adverse operating performance
These ratios are
important in evaluating those companies whose reported profit and cash flows
deviate substantially.
Among them some of
the most important cash flow ratios are as follows:
1.
Cash flow coverage ratio
2.
Cash flow margin ratio
3.
Current liability coverage ratio
4.
Price to cash flow ratio
5.
Cash flow to net income
1.
Cash flow
coverage ratio
It
refers to whether the company has sufficient cash flow to service debt and
interest on the debt. The operating cash flow
divided by total debt gives the figure of cash flow coverage ratio.
What
indication is given by the cash flow coverage ratio?
The
higher cash flow coverage ratio indicates that an organization has sufficient
cash flow to pay for principal debt amount and interest on the debt.
2. Cash flow margin ratio
This ratio depicts the relationship
between the operating cash flow and sales of the company. The operating cash
flow of a company when divided by total sales gives the figure of cash flow
margin ratio. This ratio is more reliable than net profit.
What indication is
given by the cash flow margin ratio?
It indicates the
amount of cash generated per $ of sales.
3. Current liability
coverage ratio
This ratio shows the
relationship between the operating cash flow and the current liabilities of the
company. The operating cash flow divided by the company's current liabilities
gives the figure of the current liability ratio.
What
indication is given by the current liability coverage ratio?
The current
liability ratio of less than 1 indicates the company is not generating enough
cash to meet its current obligations and is a warning signal of bankruptcy.
4. Price to cash flow
ratio
This compares the market value
of the company with the company's operating cash flow. This
ratio is considered better than the PE ratio. The current market price per share
divided by the operating cash flow per share gives the figure of price to cash
flow ratio.
What
indication is given by the price to cash flow ratio?
It indicates whether or not the
company is falsifying its market value.
5.
Cash
flow to net income
This measures amount of cash
flow generated in relation to net income.
What
indication is given by cash flow to net income?
The cash flow to net income
ratio of 1 indicates that the company is not engaged in any creative accounting
to inflate earnings above the cash flows.
Be
Aware:
Financial ratios are not all in
all. They are only indicators. They give relative values. Indicators can help
you assess the value of a stock and its growth potential. But there are many
other factors that affect stock prices that can't be easily predicted or
measured.
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