Financial Education

Just as the interest coverage ratio could be expressed using cash flow rather than accounting income, other ratios can be adjusted to represent cash flow rather than accounting income as well. Here are a few examples:

• Cash flow solvency = (Cash flow from operations)/(Total liabilities)
• Cash flow margin = (Cash flow from operations)/(Revenue)
• Cash flow ROA = (Cash flow from operations)/(Average total assets)
  

A high cash flow solvency ratio indicates that the company has plenty of cash flow to settle obligations. A low ratio could be an indication of financial distress in the future. A high cash flow margin or cash flow return on assets indicates that the company generates large amounts of cash flow relative to revenues or assets - a good sign.

In addition, cash flow from operations can be compared to net income to estimate earnings quality. A higher ratio of (cash flow from operations)/(net income) typically indicates higher earnings quality.

Also, the ability of the firm to invest in future growth can be determined if the ratio of (cash flow from operations)/(capital expenditures) is higher than one. This indicates the company is able to fund capital expenditures out of operating cash flows.

For more information, see all articles on: Financial Statement Analysis, Fundamental Analysis, Investing in Stocks, Ratio Analysis, Security Selection

See also:

Ratio Analysis

Free Cash Flow

Computing Free Cash Flow to Equity from Free Cash Flow to the Firm

Computing Free Cash Flow to the Firm from the Statement of Cash Flows

Constant Growth Free Cash Flow to the Firm Valuation Model