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Analyzing Financial Statements – Cashflow Statement

The previous two posts had discussed about metrics that are derived from a balance sheet and earnings statement. This week, we will conclude by looking at a few other metrics that are determined by using data from the third component of a corporate financial statement – the cash flow.

Consolidated Cash Flow Statement

The cash flow statement of a company shows the source and destination of the cash and cash equivalents. It does not include future inflows and outflows, i.e., those made on credit. The cash flow statement comprises of cash from operations, investing, and financing. The metrics that can be derived from it are discussed below.

Operating Cash Flow to Debt Ratio

This metric is a ratio of the operating cash flow to the total liabilities of the company.

Operating Cash Flow to Debt Ratio = Operating Cash Flow / Total Liabilities

If total liabilities are not stated explicitly, they can be calculated as

Total Liabilities = Total Assets – Shareholders’ Equity

The higher the cash flow to debt ratio, the better it is for the company. A hypothetical ratio of 1 means that the company has generated enough cash flow from operations to cover its total liabilities.

Free Cash Flow to Operating Cash Flow Ratio

This metric is a ratio of the free cash flow available (after capital expenses) to the operating cash flow.

Free Cash Flow to Operating Cash Flow Ratio = (Operating Cash Flow – Capital Expenditure) / Operating Cash Flow

Evidently, the higher the free cash flow, the better the financial health of the company.

Capital Expenditure (CAPEX) Coverage Ratio

It is a ratio of the operating cash flow to the capital expenditure of the company.

CAPEX Coverage Ratio = Operating Cash Flow / Capital Expenditure

A company should be able to meet its capital expenses through operating cash flows. Else, it will have to look to cash from financing and investing activities for support.

Dividend Coverage Ratio

Evidently, this ratio is only applicable to dividend payers. It measures the ability of the company to generate enough cash from operations to meet dividend payments.

Dividend Coverage Ratio = Operating Cash Flow / Total Cash Dividend

Ideally, a company should have a number greater than 1, so that it can meet its dividend payments. A stable company would have a ratio high enough (>>1) to meet its dividend payments and CAPEX without having to cut or stop dividends altogether.

Operating Cash Flow to Sales Ratio

This is a ratio of the cash flow from operations to the revenue of the company. It measures the ability of the company to convert sales into cash.

Operating Cash Flow to Sales Ratio = Operating Cash Flow / Revenue

A high ratio implies that the company has good growth prospects, since it would be able to finance additional production through its cash flow from operations.

Do you calculate these ratios yourself while analyzing a stock? Or, do you use the metrics provided on websites? Did you ever buy a stock for the love of the company’s product despite metrics telling you to avoid it?

About the Author: Clark works in Saskatchewan and has been working to build his (DIY) investment portfolio, structured for an early retirement. He loves reading (and using the lessons learned) about personal finance, technology and minimalism.  You can read his other articles here.

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About the author: Clark works in Saskatchewan and has been working to build his (DIY) investment portfolio, structured for an early retirement. He loves reading (and using the lessons learned) about personal finance, technology and minimalism. You can read his other articles here.

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