Cash Flow Analysis Ratios: Powerful KPIs to Manage and Grow Businesses

Written by Trovata Team
April 13, 2021

With interest rates at all-time lows, record amounts of cash are flooding into new startups and established businesses at a faster pace than ever before. Things like Special Purpose Acquisition Companies (SPACS) are growing in popularity as investment vehicles, showing that mega-round funding is the new norm with investment capital trending in the billions.

In fact, we’re seeing record numbers of funding in fintech mega-rounds; take the new payment company Ramp who recently received a  $100 million investment from fintech unicorn Stripe; then there’s Plaid, which completed its Series D funding round, valuing the company at over $10BN after Visa attempted to purchase it for $3BN earlier last year.  

Whether you’re on the giving or receiving end of new capital, now more than ever, companies need to manage risk while creating profit. Using Cash Flow Analysis Ratios is especially important for evaluating business operations and forecasting company solvency.

Read on to learn more about Cash Flow Analysis Ratios and 5 important types of Cash Flow Analysis Ratios to use at your company. 

What is a Cash Flow Analysis Ratio?

One of the most powerful Key Performance Indicators (KPI) financial professionals can use to manage and grow a business is a set of accurate and up-to-date Cash Flow Analysis Ratios that measure a company’s financial viability.  

Using these metrics to track your KPIs will provide an understanding of your company’s liquidity (its ability to pay off short-term debts) and help determine if and where your company falls short on profit.  

Cash Flow Analysis Ratios also help investors and analysts forecast and make financial decisions that will contribute to the growth of the business.  

5 Types of Cash Flow Analysis Ratios

 1. Cash Flow Liability Coverage Ratio

The Cash Flow Liability Coverage Ratio is the measurement of cash from operating activities in relation to a company’s average current liabilities.  This ratio indicates the ability for operations to generate cash for use in covering debts that need to be paid within a year.  

 How is the Cash Flow Liability Coverage Ratio Calculated?

To calculate the Cash Flow Liability Coverage Ratio, simply divide the net cash from operating activities by the company’s current liabilities.

What Does It Mean?

If this ratio is less than 1:1, it could be a sign of impending bankruptcy, indicating a company is not generating enough cash to pay for its immediate obligations.

 2. Price to Cash Flow Ratio

The appraisal of a company’s share price in comparison to its cash price determines the Price to Cash Flow Ratio, and therefore, helps determine whether or not a business is under or overvalued.  It is harder for false adjustments to be made when calculating this ratio and therefore, the Cash Flow Ratio is deemed as more reliable than the price per earnings ratio.  

How is the Price to Cash Flow Ratio Calculated?

To calculate the Price to Cash Flow Ratio, divide the day’s closing price of the share of one stock by the operating cash flow (taken from the most up-to-date statement of cash flows).

What Does It Mean?

When it comes to Price to Cash Flow Ratio, the lower the number, the better.  On average, a value of 15-20 is considered good.

 3.  Cash Flow Coverage Ratio

The Cash Flow Coverage Ratio measures a company’s solvency: the ability to pay off long-term debts with profit from its operating cash flows.      

How is the Cash Flow Coverage Ratio Calculated?

Using the statement of cash flows, the cash flow from operations is then divided by the total debt, which is a total of all of a company’s liabilities.

What Does It Mean?

A higher ratio reflects a business’s ability to pay off debts.  A ratio of more than 1 is ideal.  The higher the ratio, the more cash leftover from operations after paying off debts.

4. Cash Flow Margin Ratio

To understand the relationship between cash generated from operations and from sales, financial professionals should look to the Cash Flow Margin Ratio. This ratio provides specific data about the amount of cash generated per dollar of net sales.

More reliable than data on net profit alone, the Cash Flow Margin Ratio gives an accurate picture of the amount of cash generated per dollar of sales.

How is the Cash Flow Margin Ratio Calculated?

Dividing the Cash Flow from Operating Cash Flows by the Net Sales taken from the income statement will garner the Cash Flow Margin Ratio.

What Does It Mean?

Here, the higher the percentage, the better the company is at converting sales to cash flow.

5. Cash Flow to Net Income Ratio

The Cash Flow to Net Income Ratio measures the dollar of operating cash flows per dollar of operating income.  

If there is a large discrepancy between operating cash flows and operating income, the company may be engaged in poor accounting techniques. Ideally, this ratio should be 1:1; if not, it can indicate accounting errors intended to inflate earnings.

How is the Cash Flow to Net Income Ratio Calculated?

The Cash Flow to Net Income Ratio is calculated by dividing the cash flow from operations by the total operating income (typically before interest and taxes).  

This ratio does not take into consideration a high, one-time asset sale and therefore, can be a misleading indication of a company’s actual growth and development.

What Does It Mean?

Because the Cash Flow to Net Income Ratio measures the ability of a company to generate cash from its operations, financial professionals aim to see a ratio greater than 1.00.

Bottom Line

Cash Flow Ratios provide insight into how well a company can withstand hard times and are an essential component used in Cash Flow Analysis.  Without Cash Flow Ratios, financial professionals are unable to accurately manage and forecast business performance.   

To see how you can easily automate and analyze cash flow data, check out “A Strategic Controller’s Guide to Digital Transformation.”

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