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Operating cash flow ratio formula

If you’re an investor or you simply want to gain a deeper insight into your company’s financial health, operating cash flow ratio can be a fantastic tool. Why? Because understanding how to calculate operating cash flow to current liabilities ratio can give you enormous insight into your company’s liquidity. Find out more about this important financial metric with our definitive guide.

What is operating cash flow ratio?

Operating cash flow ratio is a metric that demonstrates whether the cash generated from ongoing activities is enough to pay for your company’s current liabilities. It can help gauge your company’s short-term liquidity, which can provide you with insight into the financial health of the business. If you’re an investor, it may indicate that a business needs more capital, although it’s always important to look at operating cash flow coverage ratio alongside other liquidity ratios like cash ratio and quick ratio.

How to calculate operating cash flow ratio

Learning how to calculate operating cash flow ratio is a relatively straightforward process. You just need to understand the formula, which is as follows:

Operating Cash Flow Ratio = Cash Flow from Operations / Current Liabilities

In this formula, “Cash Flow from Operations” refers to the amount of money your business generates from ongoing business activities. “Current Liabilities” refers to all the obligations that are due within one year, such as accounts payable and short-term debt.

As you can see, knowing how to calculate operating cash flow to current liabilities ratio isn’t too complex – you simply need to divide cash flow from operations by current liabilities. Let’s look at an example to see how this works in practice.

Imagine that Company A has a net cash flow from operations of around £250,000. However, they have current liabilities of £120,000. You can work out the operating cash flow ratio like so:

250000 / 120000 = 2.08

This means that Company A earns £2.08 from operating activities, per every £1 of current liabilities. Essentially, Company A can cover their current liabilities 2.08x over.

Advantages of operating cash flow ratio analysis

Operating cash flow ratio analysis is an effective way to measure how well a company can pay off its current liabilities using the cash flow generated from ongoing business activities. If the operating cash flow coverage ratio is greater than one, as in the example above, the company will have generated enough cash to pay off all their current liabilities for the year. However, an operating cash flow ratio of less than one indicates that the business hasn’t generated enough to cover their current liabilities.

It’s worth remembering that a lower operating cash flow coverage ratio may not always be an indication that your company has poor financial health. For example, if the business has made an investment or started a project that compromises cash flows in the short-term, but may yield long-term profits, a low operating cash flow ratio may not be something to worry too much about.

Limitations of the operating cash flow ratio

However, it’s important to remember that there are a couple of limitations associated with the operating cash flow coverage ratio. Most importantly, it is possible to manipulate cash flows – therefore giving an inaccurate picture of your company’s operating cash flow ratio – although this is much more prevalent in ratios using net income. For example, some businesses deduct depreciation expenses from revenue even though this isn’t a real cash outflow.

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