When evaluating the financial health of a company, cash flow is one of the most important things to consider. Unlike profits or balance sheets, which can sometimes be misleading, cash flow shows the actual money moving in and out of a business.
In this article, we will break down cash flow ratios in simple terms and explain how they can help you assess a company’s ability to generate cash, manage its finances, and remain financially healthy.
What Are Cash Flow Ratios?
Cash flow ratios are tools used to evaluate how well a company is generating and managing its cash. These ratios provide valuable insights into whether a company can make enough cash from its operations to pay its bills, cover its debt, and grow.
Understanding these ratios is crucial for analyzing the long-term financial health of a business.
Let’s look at some of the key cash flow ratios and how they work.
1. Cash Flow from Operations to Sales Ratio
This ratio shows how much cash a company generates from its core operations compared to its total sales. It helps us understand how good the company is at turning its sales into real cash.
Formula: Net Cash Flow from Operations ÷ Net Sales
A higher ratio means the company is efficient at converting sales into cash.
Example:
| Period | Net Cash Flow from Operations (Rs Cr) | Net Sales (Rs Cr) | Cash Flow from Operations to Sales (%) |
| Mar 2024 | 30,000 | 2,00,000 | 15% |
| Mar 2023 | 28,000 | 1,80,000 | 15.56% |
| Mar 2022 | 15,000 | 1,90,000 | 7.89% |
Explanation:
- In March 2024, the company generated 15% of its sales as cash from its operations. For every Rs 100 of sales, the company got Rs 15 in cash.
- In March 2023, the company generated 15.56% of its sales as cash.
- In March 2022, it was just 7.89%.
A higher percentage is a good sign, as it means the company is good at turning sales into cash.
2. Coverage Ratio
The coverage ratio shows how well a company can cover its interest and other finance costs using the cash it generates from operations. This ratio tells us how many times a company can pay its interest and other finance-related costs with its operating cash flow.
Formula: Cash Flow from Operations before Interest and Taxes ÷ Finance Costs
A higher ratio means the company can easily meet its finance costs with its operating cash flow.
Example:
| Period | Cash Flow from Operations before Interest and Taxes (Rs Cr) | Finance Costs (Rs Cr) | Coverage Ratio |
| Mar 2024 | 32,000 | 5,000 | 6.4 |
| Mar 2023 | 31,000 | 3,000 | 10.33 |
| Mar 2022 | 18,000 | 2,000 | 9.00 |
Explanation:
- In March 2024, the company could cover its finance costs 6.4 times with its operating cash flow.
- In March 2023, it was able to cover them 10.33 times.
- In March 2022, the coverage ratio was 9.00.
A higher ratio means less risk for the company, as it can easily handle its debt payments.
3. Cash Flow from Operations to Shareholder’s Funds Ratio
This ratio compares the cash generated by the company’s operations to the amount invested by shareholders. It shows how much cash the company is generating for every rupee of equity invested by its shareholders.
Formula: Net Cash Flow from Operations ÷ Shareholder’s Fund
A higher ratio means the company is providing good returns to its shareholders through cash.
Example:
| Period | Net Cash Flow from Operations (Rs Cr) | Total Shareholder’s Fund (Rs Cr) | Cash Flow from Operations to Shareholder’s Funds (%) |
| Mar 2024 | 30,000 | 1,00,000 | 30% |
| Mar 2023 | 28,000 | 80,000 | 35% |
| Mar 2022 | 15,000 | 75,000 | 20% |
Explanation:
- In March 2024, the company generated 30% of its shareholder equity in cash from its operations. This is a strong sign, meaning shareholders are getting a good return.
- In March 2023, the ratio was 35%.
- In March 2022, it was 20%.
A higher percentage indicates that the company is generating more cash for every rupee invested by its shareholders.
4. Asset Efficiency Ratio
This ratio tells us how efficiently a company is using its assets to generate cash. The higher the ratio, the more effective the company is at turning its assets into cash.
Formula: Net Cash Flow from Operations ÷ Total Assets
A higher ratio means the company is efficiently using its assets to generate cash.
Example:
| Period | Net Cash Flow from Operations (Rs Cr) | Total Assets (Rs Cr) | Cash Flow from Operations to Total Assets (%) |
| Mar 2024 | 30,000 | 2,00,000 | 15% |
| Mar 2023 | 28,000 | 1,75,000 | 16% |
| Mar 2022 | 15,000 | 1,50,000 | 10% |
Explanation:
- In March 2024, the company generated 15% of its total assets in cash flow. This shows good asset efficiency, even though it’s slightly lower than the previous year.
- In March 2023, it was 16%.
- In March 2022, it was 10%.
The higher this ratio, the more efficient the company is at turning its assets into cash.
5. Cash Generating Power Ratio
This ratio shows how much of a company’s total cash inflows come from its core business operations, as opposed to cash generated from investments or financing activities.
Formula: Cash Flow from Operations ÷ (Cash Flow from Operations + Cash from Investing + Cash from Financing)
A higher ratio means the company is generating more cash from its core operations, rather than relying on external financing or investments.
Example:
| Period | Cash Flow from Operations (Rs Cr) | Cash from Investing (Rs Cr) | Cash from Financing (Rs Cr) | Total Cash Inflow (Rs Cr) | Cash Generating Power Ratio (%) |
| Mar 2024 | 30,000 | 1,500 | 25,000 | 56,500 | 53% |
| Mar 2023 | 28,000 | 1,000 | 30,000 | 59,000 | 47.45% |
| Mar 2022 | 15,000 | 10,000 | 8,000 | 33,000 | 45.45% |
Explanation:
- In March 2024, 53% of the company’s total cash inflows came from its core business operations, showing strong cash generation.
- In March 2023, it was 47.45%.
- In March 2022, it was 45.45%.
A higher ratio is a good sign, as it means the company is less dependent on external financing and investments.
6. External Financing Index Ratio
This ratio shows how much a company relies on external financing (like loans or debt) compared to the cash it generates from operations. A lower ratio is a good sign, as it shows the company doesn’t depend too much on debt.
Formula: Cash from Financing ÷ Net Cash Flow from Operations
A lower ratio means the company is using less external financing.
Example:
| Period | Cash from Financing (Rs Cr) | Net Cash Flow from Operations (Rs Cr) | External Financing Index Ratio (%) |
| Mar 2024 | 2,000 | 30,000 | 6.67% |
| Mar 2023 | 5,000 | 28,000 | 17.86% |
| Mar 2022 | -1,000 | 15,000 | -6.67% |
Explanation:
- In March 2024, the company used only 6.67% of its cash flow for external financing, which shows financial independence.
- In March 2023, it used 17.86%.
- In March 2022, it had negative financing (meaning the company had more cash inflow from financing activities than it needed).
A lower ratio means the company is less dependent on debt or external financing.
Why These Ratios Matter
Cash flow ratios provide insights into a company’s ability to generate cash from its operations, cover its debts, and continue growing. They are important for investors, creditors, and anyone interested in understanding how financially healthy a business is.
Key Takeaways:
- Cash Flow from Operations to Sales Ratio: Shows how much cash a company generates from its sales. A higher ratio is better.
- Coverage Ratio: Indicates how well a company can cover its finance costs with its operating cash. A higher ratio is better.
- Cash Flow from Operations to Shareholder’s Funds Ratio: Measures cash generated for shareholders. A higher ratio is good.
- Asset Efficiency Ratio: Shows how well a company uses its assets to generate cash. A higher ratio is better.
- Cash Generating Power Ratio: Shows how much cash comes from the company’s core business operations. A higher ratio is better.
- External Financing Index Ratio: Measures how much the company relies on external debt. A lower ratio is better.
By understanding these ratios, you can gain a clearer picture of a company’s financial health and its ability to grow and manage its operations successfully.
