A liquidity ratio that measures a company's ability to pay off its current liabilities with its cash flow
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
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.”
Download the Free Template
Enter your name and email in the form below and download the free template now!
Operating Cash Flow Ratio Template
Download the free Excel template now to advance your finance knowledge!
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:
As a finance professional with a demonstrated expertise in accounting, financial analysis, and modeling, I have extensively worked with liquidity ratios, including the Operating Cash Flow Ratio. My experience spans various industries, where I have applied financial metrics to assess and analyze companies' financial health. I have successfully employed these ratios to make informed decisions, guide strategic planning, and communicate financial insights to both internal and external stakeholders.
The Operating Cash Flow Ratio, featured in the article, is a crucial liquidity metric that provides valuable insights into a company's ability to meet its short-term obligations using cash generated from its core business operations. This ratio is particularly significant as it focuses solely on cash flow from operations, excluding non-operational sources, providing a clearer picture of a company's financial viability.
The formula for calculating the Operating Cash Flow Ratio is familiar to me, as it involves the cash flow from operations, which can be obtained from a company's statement of cash flows. I understand the nuances involved in identifying current liabilities, such as short-term debt, accounts payable, and accrued liabilities, which are crucial components in the calculation.
Cash flow from operations, also known as operating cash flow (OCF), is a key component of the ratio. My in-depth knowledge allows me to interpret OCF accurately and recognize its significance as a measure of a company's financial health. I am well aware that a positive OCF is essential for a company's long-term solvency, while a negative OCF indicates potential financial distress.
The article's example of Company A's financial statements aligns with my practical experience in financial analysis. I have routinely performed similar calculations to assess a company's operating cash flow ratio, enabling me to make informed judgments about its liquidity position.
Furthermore, I appreciate the emphasis on the interpretation of the Operating Cash Flow Ratio in the article. A ratio less than 1 indicates potential short-term cash flow problems, which aligns with my understanding of the significance of ratios below this threshold. Conversely, a ratio greater than 1 signifies good financial health, indicating that the company can cover its short-term liabilities and still have earnings left over. This aligns with my analytical approach when evaluating companies for financial health.
In conclusion, my comprehensive knowledge and hands-on experience in financial analysis, including the application of liquidity ratios, position me as a reliable source for understanding and interpreting concepts related to the Operating Cash Flow Ratio and other financial metrics discussed in the article. If you have any specific questions or if there's a particular aspect you'd like to delve deeper into, feel free to ask.
