This is an ultimate guide on how to calculate Operating Cash Flow to Sales Ratio with detailed interpretation, analysis, and example. You will learn how to use its formula to assess a company's efficiency.
Definition - What is Operating Cash Flow to Sales Ratio?
The operating cash flow to sales ratio (OCF/S) is the ratio of a company's operating cash flow and its net sales.
This ratio is used to compare a company’s sales revenues with its cash flow from operations, thereby revealing how well the company can generate cash flows from its sales.
It is important for a business to root its success not only in sales or revenue figures, but also in cashflow. This is especially true for companies with long-standing receivables.
As an investor, you don’t want to invest in a company that has cash problems since cash is one of the most important factors that creates “value” in a business.
While seeing an exciting swell of figures in the revenue line may make you want to turn your money in immediately, you need to inspect if these figures have actually materialized into something tangible and usable by the business.
This is where you want to check the operating cash flow figure, which indicates how the money flows into a business from its operating activities.
The OCF to sales ratio is a very useful metric for evaluating a company’s efficiency.
Not only will it help you understand how a business generates cash flow from its sales, but this ratio also will tell you if that business has any problems with its accounts receivable.
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Formula
In order to calculate the operating cash flow to sales for a company you would like to evaluate, you can use the following formula:
Operating Cash Flow to Sales Ratio = Operating Cash Flow / Net Sales
You can easily find the operating cash flow and net sales reported on the company’s financial statements.
Example
Now let’s consider a quick example so you can understand clearly how this ratio works in real life.
Company A and Company B both have similar product lines that are selling well on the Market.
Company A | Company B | |
|---|---|---|
Operating Cash Flow | $ 390,000 | $ 640,000 |
Net Sales | $ 450,000 | $ 450,000 |
OCF / Sales | 0.87 | 1.42 |
Upon inspection of A and B’s cash flow statements, Company B has a better OCF to Sales ratio.
The result shows that Company A’s cash collection system is inefficient and it may be experiencing problems when collecting money from its customers.
Interpretation & Analysis
A big sales figure is important, but a significant cash flow figure is even better.
Ideally, this ratio value should be greater than 1.0.This indicates that the business has at least reached its break-even point, and generated enough cash flow from its sales.
So what is a good operating cash flow to sales ratio?
Well, similar to other efficiency ratios, there’s no standard value or guideline for this ratio. In fact, the higher the ratio, the better.
To use this ratio effectively, you should also consider comparing the ratio value of one company with that of its competitors.
By doing so, you can easily determine which company is more efficient in creating cash flow from selling its products or services.
Cautions & Further Explanation
From another perspective, the operating cash flow to sales ratio can also become a good indicator of how efficient a business is in terms of collecting money from its customers.
It should be noted that a company’s operating cash flow should be in correlation with its sales revenue. If the business reports a growth in sales, there should also be a growth in operating cash flow.
Your business is raking in the sales, but it may not necessarily be bringing in cash flow - this is the problem!
In fact, sales can be easily inflated by a company by changing its credit policy, thereby encouraging more customers to buy on credit.
Not only this makes the sales increase significantly, but also the accounts receivable.
If the sales increases dramastically while cash flow does not increase or remain the same, this may be a warning sign that the business is facing troubles when collecting money from its customers.
