Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Operating Cash Flow Ratio

What it is:

The operating cash flow ratio is cash from operating activities as a percentage of current liabilities in a given period. 

How it works (Example):

Operating cash flow ratio is generally calculated using the following formula:

Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities 

The operating cash flow ratio is not the same as the operating cash flow margin or the net income margin, which includes transactions that did not involve actual transfers of money (depreciation is common example of a noncash expense that is included in net income calculations but not in operating cash flow). The operating cash flow ratio is also not the same as EBITDA or free cash flow.

Because working capital is a component of operating cash flow, investors should be aware that companies can influence the operating cash flow ratio by lengthening the time they take to pay the bills (thus preserving their cash), shortening the time it takes to collect what's owed to them (thus accelerating the receipt of cash), and putting off buying inventory (again thus preserving cash).

Why it Matters:

The operating cash flow ratio is a measure of a company's liquidity. If the operating cash flow is less than 1, the company has generated less cash in the period than it needs to pay off its short-term liabilities. This may signal a need for more capital. Thus, investors and analysts typically prefer higher operating cash flow ratios.

It is important to note, however, that having low operating cash flow ratios for a time is not always a bad thing. If a company is building a second manufacturing plant, for example, this could pay off in the end if the plant generates more cash.