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Operating cash flow to sales ratio

A company's operating cash flow to sales ratio gives you an idea of a company's ability to turn sales into available cash. It is calculated by dividing its operating cash flow by its net sales revenue and multiplying the total by 100. It is expressed as a percentage:

Operating cash flow to sales = (cash flow/revenue) x 100

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For example, a company with £700 million in operating cash flow and net sales revenue of £2.8 billion would have an operating cash flow to sales ratio of 25%.

Every £1 that it earns in sales therefore gives it 25 pence of cash flow that it can then use to pay suppliers and employees, invest in equipment and distribute to shareholders as dividends.

Although there isn't a rule-of-thumb percentage that is considered optimal for companies, the higher the percentage the better.

If a company’s operating cash flow to sales ratio drops, this means that any sales growth is not being reflected in its cash flow. This could suggest it is being paid more slowly for its goods or services or is managing its receivables less efficiently.

 

Pay close attention to changes

If a company's operating cash flow to sales ratio drops, for example, this means that any growth in its sales is not producing as big a growth in its cash flow.

This might suggest that it is being paid more slowly for its goods or services or is managing its receivables less efficiently.

It places the company more at risk of not being able to pay its obligations. This makes its future more uncertain and can force down its share price.

In a less extreme scenario, it might mean that you the shareholder will see any dividend income from your investment decline if the company's shares fall.

 

Summary

So far you have learned that...

  • ... calculating a company's operating cash flow to sales ratio gives you an idea of a company's ability to turn sales into available cash.
  • ... although there isn't a rule-of-thumb percentage that is considered optimal for companies, the higher the percentage the better.
  • ... pay close attention to changes, because if a company's operating cash flow to sales ratio drops, for example, this means that any growth in its sales is not producing as big a growth in its cash flow.

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