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What is an Operating Cash Flow Ratio?

By Osmand Vitez
Updated May 16, 2024
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An operating cash flow ratio is a financial measure used to determine how well a company can meet current liabilities with operational cash flows. Operational cash flows represent all money brought into the business through producing and selling various goods or services. The basic formula for this ratio is total cash flow from operations divided by the company’s current liabilities. This ratio is part of a larger financial management analysis technique using ratio calculations. The operating cash flow ratio falls under the liquidity measurements used by financial or accounting managers.

The cash flow from operations includes three items: earnings before income taxes (EBIT), depreciation, and taxes. These items represent the major cash flow functions of a company. EBIT is usually the bottom number on a company’s income statement. Income statements include sales, sales discounts, cost of goods sold, and expenses for specific time period. The result of these financial numbers is net income before taxes, also known as EBIT.

Depreciation in the operating cash flow ratio represents non-cash write-offs companies record to decrease the value of fixed assets. Fixed assets often include facilities, production equipment, vehicles, and other similar items. Depreciation is added back to EBIT because it is an expense recorded on the company’s income statement. This number is merely an accounting figure that does not represent a physical financial transaction from business operations.

The operating cash flow ratio often estimates the taxes to deduct from each month’s net income. This figure usually reflects the historical tax rate companies are assessed on business income. It is deducted from the numerator of the operating cash flow ratio because it is a future cash outflow.

Current liabilities are the denominator in the operating cash flow ratio. This figure represents any debts obligations that will mature in less than one year. Short-term debt, accounts payable, accrued liabilities, and similar short-term debt usually represent company’s current liabilities. Companies often pay close attention to this number since these cash outflows must be paid out in the near future.

The calculation result from the operating cash flow ratio is usually expressed as a financial indicator. This indicator is discussed in financial monetary terms. Companies with an operating financial cash flow ratio of 1.0 is often said to have $1 United States Dollar (USD) of cash for every $1 USD of current liabilities. This result indicates the company has achieved an equilibrium point of available cash versus current liabilities. Therefore, ratios higher than 1.0 are considered positive with results less than 1.0 seen as negative.

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