Cash Flow Ratios

by Obaidullah Jan, ACA, CFA

Cash flow ratios are financial ratios in which either the numerator or the denominator or both is a cash flow figure. Important cash flow ratios include cash flow per share, cash to income, debt coverage, interest coverage, cash return on equity and cash return on assets.

Financial accounting ratios which are based on income statement and/or balance sheet are more popular because accrual-based recognition of assets, liabilities, income and expenses is generally considered to be a better indicator of financial performance. It is because under accrual basis, revenues and expenses are recognized when they are incurred and not when they are paid. But because accounting standards allow management discretion in some accounting policies and many accounting policies require application of estimates, accrual-based financial figures are prone to manipulation. Many analysts believe that cash flows are relatively less sensitive to management discretion and this is why they analyze the cash flow ratios too.

Cash flow ratios are based on the cash flow statement and/or income statement and/or balance sheet. Cash flow statement is a component of financial statements that report presents a company’s cash flows during a period broadly categories into three sections: cash flows from operating activities (CFO), cash flows from investing activities (CFI) and cash flow from financing activities (CFF). Many cash flow ratios are based on cash flow from operating activities (also called cash flows from operations).

The following table shows a list of popular cash flow ratios, their numerator, their denominator and the equivalent traditional accrual-based financial ratios

Ratio Numerator Denominator Equivalent traditional ratio
Cash flow per share CFO – preferred dividends Weighted average number of common shares outstanding Earnings per share
Cash flow to revenue CFO Net revenue Net profit margin
Interest coverage ratio CFO + Interest Payment + Tax Payment Interest Payment Times interest earned ratio
Debt coverage ratio CFO Total debt
Cash return on assets CFO Average total assets Return on assets
Cash return on equity CFO Average common stockholders’ equity Return on equity
Dividend payment coverage ratio CFO Dividend payment Dividend coverage ratio
Debt payment coverage ratio CFO Debt payment
Cash to income CFO Net income
Price to cash flow Stock price Cash flow per share Price to earnings ratio
Operating cash flow ratio CFO Current liabilities

Cash flow per share calculates the cash flow from operations per share of common stock. The preferred dividends paid is subtracted from CFO to arrive at the net cash flows from operations attributable to common stock-holders which is then divided by weighted average number of shares.

Cash flow to revenue ratio measures dollars of net cash flows from operating activities per $1 of net revenue. A higher value is better because it shows that a company's operating expense payments are low relative to operating cash inflows.

Interest coverage ratio assesses the sufficiency of cash flows from operations with respect to interest payment obligations. It calculates dollars of CFO per dollar of interest payment. Interest and tax payments are added back to CFO just like interest expense and tax expense is added back to net income while calculating times interest earned ratio.

Debt coverage ratio is a solvency ratio which measures cash flows from operations as a percentage of total debt. A higher ratio is better because it tells that more CFO is available per dollar of debt.

Cash return on assets and cash return on equity calculates the percentage of cash generated from operations with respect to average balance of assets and average balance of shareholders equity respectively.

Cash to income ratio measures the dollar of operating cash flows per dollar of operating income. If there is a large disconnect between operating cash flows and operating income, it shows that the company might be engaged in creative accounting.

Price to cash flow ratio is a valuation ratio which attempts to value a stock based on net cash flows from operating activities that it generates.

Operating cash flow ratio measures adequancy of cash flows from operations in a given year with reference to current liabilities. It is a cash-flow based liquidity ratio.