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What is an operating cash flow ratio?

Operating cash flow ratio

The operating cash flow ratio, also known as a liquidity ratio, is an indicator which helps to determine whether a company is able to repay its current liabilities with cash flow, coming from its major business activities.

Otherwise stated, the operating cash flow can show how much the company gets from its major business operations per dollar of current liabilities. 

Where have you heard about the operating cash flow ratio?

Cash flow ratio is preferred by analysts as more precise and accurate parameter of the company’s liquidity. Since earnings are more easily manipulated, using cash flow is preferred as a more effective measurement.

The operating cash flow ratio formula looks as follows:

  • Operating cash flow may be taken from the company’s cash flow statement. Also, there is a special formula to define the operating cash flow, which is calculated as a sum of net income + non-cash expenses + working capital changes.

  • Current liabilities presuppose obligations, which are due within a year. They usually include accounts payable, short-term debt and accrued liabilities. 

What you need to know about the operating cash flow ratio.

The cash flow from operations, or OCF, is a key metric in companies’ account statements. It shows how much cash a business can generate exclusively from its major operations. Investors closely view the OCF, as it gives them a clear picture of the company’s overall value and health. 

Cash flow from operations serves as a cash equivalent of net income. It means the cash flow after deduction of operating expenses before the start of new financial activities. Investors choose to follow cash flow from operations over net income, because here the risk of manipulating results is much lower. However, seen together net income and operating cash flow provide a good means to estimate the quality of the company’s earnings.

Failure to maintain a positive OCF, is a trigger, which notifies investors that the company probably won't stay solvent in the long run. A negative OCF shows that the company has not enough revenues from its major business activities and needs to reproduce a positive cash flow from additional investments and financing.

The ratio serves as a measurement of the company’s liquidity. When the operating cash ratio example is lower than 1, the business generates less cash than expected to repay the short-term liabilities. It brings a need for more capital. A ratio higher than 1 is considered positive and favoured by investors, analysts and creditors as it shows the company is pretty strong with enough money to pay off its current liabilities and have more capital left. Companies with a gradually increasing and high operating cash flow ratios are regarded as strong businesses in good financial health.

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