Definition
This ratio compares the operating cash flows a company to its sales revenue. This ratio gives the analysts and investors indications about the ability of a company to generate cash from its sales. In other words, it shows the ability of a company to turn its sales into cash. It is expressed as a percentage.
Ideally there should be a parallel increase in operating cash flows with the increase in sales. It will be worrisome if the changes in cash flows are not parallel to the changes in sales revenue. If the cash flows do not increase with the increase in sales it may indicate the following two factors:
- The change in terms of sales
- Inefficient or ineffective management of trade receivables
The higher this ratio is the better it is for the company. Greater amounts of operating cash flows are always desirable. Although there is not any standard guideline for this ratio but a consistent and/or increasing trend in this ratio is a positive indication of good debtor’s management. Companies with such a trend in this ratio are good investment opportunities.
Cash is very important for all companies. Cash is needed for payments to suppliers, employees, shareholders, and for operating expenses and investment in capital assets. Therefore, cash is just as important as sales and profits. This ratio indicates the ability of a company to translate its sales into cash.
Calculation (formula)
The formula for this ratio is simple. This ratio can be calculated from the following formula:
Operating cash flow / Sales Ratio = Operating Cash Flows / Sales Revenue x 100%
The figure for operating cash flows can be found in the statement of cash flows. It is also sometimes described as “cash flows from operating activities” in the statement of cash flows. The figure for sales revenue can be found in the income statement.
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