What is the Operating Cash Flow Margin?
Operating cash flow margin is a cash flow ratio which measures cash from operating activities as a percentage of sales revenue in a given period. Like operating margin, it is a trusted metric of a company’s profitability and efficiency and its earnings quality.
The cash flow margin is one of the more important profitability ratios for a company / firm. It tells how well the company / firm converts sales to cash—and cash is of critical importance because it’s required to pay expenses. The conversion of sales to cash is vital.
Profitability ratios show a firm’s overall efficiency and performance. These ratios can be divided into two types: Margins & Returns
Ratios that show Returns represent the firm’s ability to measure the overall efficiency of the firm in generating returns for its shareholders / Business Owner.
Levered free cash flow is the “free” cash flow that’s left after a business has met its financial obligations on any outstanding accrued debt. The levered cash flow is the amount of cash left over for stockholders after all financial obligations are met.Levered Free Cash = Cash flows – Debt Obligation (Interest Payments / EMI Payment)
How Is Cash Flow Margin Calculated?
The cash flow margin is a measure of how efficiently a company converts its sales to cash. Because expenses and purchases of assets are paid from cash, this is an extremely useful and important profitability ratio. It’s also a margin ratio.
Working Example:Assuming company ABC recorded the following information for 2018 business activities:Sales = Rs. 5,000,000Depreciation = Rs. 100,000Working Capital = Rs. 1,000,000Net Income = Rs. 2,000,000And recorded the following information for 2019’s business activities:Sales = Rs. 5,300,000Depreciation = Rs. 110,000Working Capital = Rs. 1,300,000Net Income = Rs. 2,100,000We calculate the cash flow from operating activities for the 2019 as:Cash Flow From Operating Activities = Rs. 2,100,000 + (Rs. 110,000) + (Rs. 1,300,000 – Rs. 1,000,000) = Rs. 2,510,000To arrive at the operating cash flow margin, this number is divided by sales: Operating Cash Flow Margin = Rs. 2,510,000 / Rs. 5,300,000 = 47.35%
What Is the Net Profit Margin Ratio?
Net Income/Net Sales = ________ percent
Meanwhile, the net profit margin indicates how well the company converts sales into profits after all expenses are subtracted out. Because industries are so different, the net profit margin is not very good at comparing companies in different industries.
- Keep in mind that this is not the same as the Net Income Margin, which includes non-cash transactions such as bad debt expenses and depreciation.
- Cash Flow Margins although higher is better.
- There is no “perfect” percentage to aim for because all companies are different.
- A firm that shows an increasing cash flow margin from year-to-year is certainly getting stronger with time, and this is a good indicator of its probability for long-term success.
- This is an important indicator for a banker / lender to arrive at the viability of the firm they are funding (may not be true for start – ups).
- Negative cash flow may not mean losing money if the same is invested in new project / expansion.
- Working Capital can be added through short term debt to capitalise on opportunities in business and is better than raising equity (helps in maintaining the cash flow margin without altering it)
- Profit margins helps firms to calculate its profitability and bottom line.
1. Start calculating Operating Cash Flow Margins in Monthly / Quarterly / Yearly basis, this help you to keep track of the health of your business. Remember what gets measured, gets done.
2. You may take help of your auditor or financial planner to develop a simple excel sheet, where you can enter data on a monthly basis based on your current and previous year balance sheets.
3. It is advisable to calculate your bottom line on a quarterly and half yearly basis to take required course correction to achieve your financial goals for the year.
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