Series C Financing
In the previous articles, we have already learned that businesses do not raise all the funds that they need to build their business at an early stage. Instead, they develop a series of milestones that chart the path of the startup firm. At each stage, enough funds are raised to enable the firm to reach […]
Valuation of Sports Franchise: Replacement Cost Approach
In the previous few articles, we have already come across the income-based approaches that are used in order to value a sports franchise. We have also had a closer look at some of the shortcomings of the income-based approach. We are also aware that the income-based approach is not the only possible way to value […]
Debt Schedule in Financial Modelling
The inability to manage debt is one of the biggest reasons behind the failure of many companies. Just in the past year, giants like Toys R Us and Sears had to file for bankruptcy because they were unable to manage their debt. Leverage is essential in today’s world since it allows a company to expand […]
Current Ratio – Formula, Meaning, Assumptions and Interpretations
The current ratio is the most popularly used metric to gauge the short term solvency of a company. This article provides the details about this ratio. Formula Current Ratio = Current Assets / Current Liabilities Meaning Current ratio measures the current assets of the company in comparison to its current liabilities. This means that the […]
Notional Value: Derivatives Markets
People often say that the size of the derivative markets is exploding. It is over $700 trillion dollars a year now and when we put that number into perspective that is over the GDP of all the countries in the world combined in the last 20 years. How can the value of derivatives in one […]
The free cash flow to operating cash flow ratio is different from other ratios. It is different in the sense that it is comparing two measures of cash flow. Usually cash flow ratios compare a cash flow item to an item on the income statement or on the balance sheet. Here are the details of this ratio:
The terms used in the ratio i.e. operating cash flow as well as free cash flow have been described in the cash flow section. But here is a quick refresher.
Operating Cash Flow: Operating cash flow is considered by many to be the most appropriate measure of cash flow. It measures the cash flow that the company has been able to generate from its regular day to day operations. Cash flow generated from onetime events such as sale of assets and investments is not a part of this. Hence investors can expect this cash flow to continue in the next period.
Free Cash Flow: Free cash flow is not listed on the cash flow statement. Rather it is derived by subtracting the capital expenditure from operating cash flow. This measure is important because this is the amount of cash flow that the investors have left after meeting the growth needs of the firm.
The name of the ratio pretty much gives away the formula. The formula is as follows:
Free Cash Flow to Operating Cash Flow Ratio = Free Cash Flow / Operating Cash Flow
This ratio tells the investors about how much free cash flow is being generated for every rupee of operating cash flow. A higher ratio means company is not investing too much in capital expenditure and therefore maybe a mature company that is not seeking any more growth but rather seeking to sustain its operations.
Mature stable firms do not need to make too many capital investments and thus have a higher ratio. On the other hand companies that are growing will have a lower ratio. One needs to start questioning if mature companies have lower ratios or vice versa.
A company with a high gestation period will invest more and more each year, the effects of which will not be visible in the free cash flow to operating cash flow ratio until many years.
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