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Operating cash flow ratio

The operating cash flow ratio calculator is a friendly tool that helps you calculate how well its operating cash flow covers the company's current financial debt. This article will review the operating cash flow ratio and what is a good value for it. Besides, we will review and calculate the operating cash flow ratio formula. We will conclude by analyzing two public companies of the same industry based on this cash flow ratio and making suggestions about other insightful debt to cash ratios.

What is the operating cash flow ratio?

The operating cash flow ratio is a financial relationship that expresses how well the operating cash flow covers the company's current liabilities.

We will start by explaining that the operating cash flow refers to the real money a company makes or loses over a fiscal period. It is also known to be more precise than the net income, EBIT, or even EBITDA because it not only includes extra cash flows that entered or left the company such as deferred contracts or stock compensations but also includes the effect of the business operating cycle cash flows. In other words, it considers variations in inventory, accounts receivables, and accounts payable. Keep in mind the last one since it is an important part of the operating cash flow ratio interpretation.

On the other hand, current liabilities are all debts that the company has due in 1 year or less. As per the International Accounting Standard #1 (IAS 1), in this category, we will commonly find the following items:

  • Short term debt;
  • The current part of long term debt;
  • Accounts payable;
  • Accruals for the employee;
  • Dividends payable; and
  • Any other financial liability that complies with a due time, as stated above.

Accounts payable refers to the money owed by the company to its suppliers, and it is one of the three main components of the business operating cycle, also known as operating working capital: inventory, accounts receivables, and accounts payable. The importance of this is that the current liabilities are expected to be paid with the rotation of the current assets in order to close the cash conversion cycle.

Operating cash flow ratio formula

So, how to calculate operating cash flow to current liabilities ratio? The operating cash flow ratio formula includes components from the cash flow statement and the balance sheet; thus, it is not accurate to just pick up the quarter values and compare them.

The current liabilities are a single point of the company's situation at the end of the fiscal period and show the historical variation of all the current debt, similar to other balance sheet components. In that sense, it is different than the values shown in the income statement and cash flow statement that start accumulating results every time again since the beginning of the fiscal year.

Consequently, we will require the last 12-month operating cash flow results, also known as TTM (twelve-month trailing) value. Don't worry, it's easy, and with our cool operating cash flow ratio calculator, even more so. The formulas are as follows:

Operating cash flow ratio = Operating cash flow TTM / Current liabilities

Operating cash flow TTM = Operating cash flow Q4 + Operating cash flow Q3 + Operating cash flow Q2 + Operating cash flow Q1

The Operating cash flow Q4 represents the value we get at the end of the most recent fiscal quarter, Operating cash flow Q3 represents the value obtained from one quarter before the last one, and so on until we cover the data from the past twelve months. The advanced section of our operating cash flow ratio calculator can help you with this or if you prefer, jump to the last section for a real example.

What is a good operating cash flow ratio?

Before starting the analysis, it is critical to remember that current liabilities consist of two subcategories: interest-bearing current liabilities such as bank loans and non-interest-bearing current liabilities like accounts payable. Furthermore, from a cash flow standpoint, a high accounts payable means a cash source because the company is not spending money to pay suppliers; thus, keeping money for doing even more operations. Of course, this cannot be forever. Suppliers have to be paid at some point!

But, what is then a good operating cash flow ratio? The answer is a ratio over one because that will mean the company is making enough money from operating activities to cover all the current liabilities and even sparing money for covering growth expenses as explained in the free cash flow.

A value between 0.5-1 is still acceptable if components of current liabilities are mostly non-interest bearing. Besides, this ratio assumes that all the current liabilities are to be paid by the operating cash flow. That's not 100% true. As mentioned above, current assets are also expected to cover it. Consequently, we should take a look at the current ratio and the quick ratio at the same time.

An operating cash flow to current liabilities ratio under 0.5 might be risky. Here it is essential to see the interest coverage ratio to find out how well covered are the interest-bearing obligations.

To conclude this section, we have to remember that each industry has its own business model, so what is a good operating cash flow ratio can vary. Even low values can be acceptable if the operating cash flow and free cash flow are having a decent growth rate. Just remember that dividends might be cut out during times of distress

How to calculate operating cash flow to current liabilities ratio: Real analysis

Skyworks (NASDAQ: SKWS) is an international semiconductor company deep in the 5G business. It is believed to be a home run because of the number of chips included in the last Apple iPhone 12.

However, for building an investment thesis based on such expectations, it is essential to review how financially well covered the company is. We can do that by using our handy operating cash flow ratio calculator; we just need the last financial information released in November 2020, the 2020 annual report. Then, we will have:

Operating cash flow = 1,204 million USD

Current liabilities = 448.4 million USD

and by using the operating cash flow ratio formula:

Operating cash flow ratio = 2.69

We can see that this company has a wide operating cash flow coverage ratio. In case something negative happens to the business, it can quickly pay all its liabilities and still has some spare cash.

On the other hand, we have Cirrus Logic (NASDAQ: CRUS), an audio chipmaker that also produces components found on iPhones. Because at this time, CRUS just issued its second quarter report, we will also need previous reports to get the operating cash flow TTM. You can find all of them in the Cirrus Logic quarterly results archive. Then we have:

Operating cash flow Q4 = 41.6 million USD, from the 2nd quarter report (most recent presented report).

Operating cash flow Q3 = 0.5 million USD, from the 1st quarter report (three months before the most recent presented report).

Operating cash flow Q2 = 49.3 million USD, from the last year, 4th quarter report (six months before the most recent presented report).

Operating cash flow Q1 = 128.7 million USD, from the last year, 3rd quarter report (nine months before the most recent presented report).

Which add up to:

Operating cash flow = 220.1 million USD

Moreover, taken from the last report balance sheet, we obtain,

Current liabilities = 178 million USD

And by using our super operating cash flow ratio calculator, we get:

Operating cash flow ratio = 1.23

Here we can see that the operating cash flow to current debt ratio for Cirrus Logic is equal to 1.23, meaning that all the current liabilities are 1.23x times covered by the net cash flow from operations.

As a final comment, and by considering how disruptive the microchip industry can be, we would be in a more solid position by choosing Skyworks since it has more coverage over the current liabilities than Cirrus Logic. Just remember: "The more speculative the investment, the more you should care about debt to cash ratios''.

Still, it is critical to keep in mind that this is just one operating cash flow coverage ratio. It is highly recommended you to check our set of amazing financial tools that can give you an overall understanding of a company's operational efficiency, and profitability.

Arturo Barrantes