Cash Flow to Sales Ratio is a performance metric that represents a business’s operating cash flow once all capital expenditures related to sales have been deducted. Cash flow is an important element in evaluating a company’s financial state and intrinsic valuation.
The Cash Flow to Sales Ratio should be recorded during a period of time and be compared with other companies’ numbers for it to provide meaningful insights and understand implications more clearly.
As with other financial ratios, the Cash Flow to Sales Ratio should not be interpreted by itself. Instead, it should be compared with other financial ratios, such as Return on Assets, Price to Earnings, and the rest. Also, it must be monitored over a particular period of time instead of merely a specific time so that patterns can be gleaned and used to control the company’s future movement.
Cash Flow to Sales Ratio Formula
$$Cash\: Flow\: to\: Sales = \dfrac{Operating\: Cash\: Flow}{Net\: Sales}$$
Cash flow is the amount of cash left after a company’s capital expenditures have been deducted from its operating cash flow. All numbers required to compute for cash flow are found in the financial statements of the business being investigated.
Cash Flow to Sales Ratio Example
By the end of 2019, Whimwick Studios, an animation company, had pulled in a total sale of $350.4 billion, with an operating cash flow of $136.2 billion and capital expenditures of $11.6 billion. What is Whimwick’s Cash Flow to Sales Ratio?
Let’s break it down to identify the meaning and value of the different variables in this problem.
Cash Flow to Sales Ratio: unknown
Operating Cash Flow: 136,200,000 – 11,600,000
Net Sales: 350,400,000
Now let’s use our formula:
$$Cash\: Flow\: to\: Sales = \dfrac{Operating\: Cash\: Flow}{Net\: Sales}$$
We can apply the values to our variables and calculate Cash Flow to Sales Ratio.
Cash Flow to Sales = (136,200,000 – 11,600,000) / 350,400,000
In this case, Whimwick Studios would have a Cash Flow to Sales Ratio of 35% for 2019.
Obviously, the company has a rather high Cash Flow to Sales Ratio, which is a sign of its exceptional ability to turn its sales into free cash. Practically speaking, it reveals that the company is profiting big, allowing it to grow steadily.
Cash Flow to Sales Ratio Analysis
Although there are some small variations in the way companies calculate their cash flows, the Cash Flow to Sales Ratio is usually determined by removing capital expenditures from operating cash flows. Yearly capital expenditures are necessary to maintain an asset base and prepare for future growth.
Cash flow is important to the company and its owners because this money will dictate the size of dividends that can be distributed among shareholders and the reduction of shares outstanding by buying back shares (thereby raising earnings per share, granted that all other values are unchanged), as well as decide on acquisitions that build on the company’s expansion plans. The way a company handles cash flow is part of its capital distribution policies.
Clearly, the more cash flow a company has, the healthier its financial position is. In general, a ratio greater than five percent is favorable because it shows that a company has a great ability to generate enough cash to fund its growth. This will also be good for the company’s image, especially in the eyes of shareholders. However, if a business’s revenue is all spent on capital expenditures and leaves almost nothing to fund growth, then there is no reason to be complacent.
Cash flow is essentially cash that the company is has once all its operating costs have been settled. This is the money used by the business to pay for its debts and other financial obligations, distribute dividends among shareholders, or reinvest for growth. Therefore, the bigger the cash flow, the better. The higher the Cash Flow to Sales Ratio, the more ability a company has of turning its sales into really matters at the end of the day: cash. Monitoring trends and comparing ratios with other parallel companies also provides clues into the market competitiveness of the business.
Remember that Cash Flow to Sales Ratios must be tracked over a certain length of time when a company is rapidly growing. Hence, negative or low cash flow is not always a sign of trouble. It could simply mean that the business is investing heavily to prepare for an expected increase in demand. The ratio may low or even negative for a year or two, but is likely to increase and stabilize soon after.
Even though cash-based ratios are often more accurate, remember that a company’s total cash flow is very easy to manipulate. Also, keep in mind that the Cash Flow to Sales Ratio is not the only way to evaluate a company’s fiscal health.
By itself, it should be used merely as a sign that the business’ financial status must be investigated further. If other areas appear to be doing fine, then it is safe to say that the business is financially stable.
Cash Flow to Sales Ratio Conclusion
- The Cash Flow to Sales Ratio reflects the amount of cash a company is making once its capital expenditures have been considered.
- The Cash Flow to Sales Ratio formula requires two variables: Operating Cash Flow and Net Sales.
- The Cash Flow to Sales Ratio is usually expressed as a percentage.
- The Cash Flow to Sales Ratio must be monitored over a span of time or in comparison with the ratios of other companies within the same industry.
- The higher a company’s Cash Flow to Sales Ratio, the more capable it is of converting its sales into cash.
Cash Flow to Sales Ratio Calculator
You can use the Cash Flow to Sales Ratio calculator below to quickly determine the amount of money a company makes outside of its capital expenditures, by entering the required numbers.