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

Operating Cash Flow Margin

What it is:

Operating cash flow margin is cash from operating activities as a percentage of sales in a given period. 

How it works (Example):

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

Operating Cash Flow Margin = Cash Flow from Operating Activities / Sales 

The operating cash flow margin is not the same as 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 margin 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 margin 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:

No matter how one measures it, cash flow is what helps companies expand, develop new products, buy back stock, pay dividends, or reduce debt. This is why some people value cash flow -- and operating cash flow margin in particular -- more than just about any other financial measure out there, including earnings per share. Thus, revenues, overhead, and efficiency are big drivers of cash flow, and the trends in operating cash flow margins are very telling.

Without positive cash flow, a company may have to borrow money, raise additional equity, or simply not stay in business. It is important to note, however, that having negative operating cash flow margins 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.

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