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Most multinational companies registered in America have business interests outside of the United States. Since the United States has a worldwide tax system, the business income generated abroad is also subject to taxation in the US as well. However, they do not have to pay these taxes immediately. American corporations can use certain tax-deferral rules […]
What is Asset Light Business Model, Its Advantages and Disadvantages
It is common knowledge that the world’s largest cab service Uber does not own any vehicles. Similarly, one of the world’s largest boarding and lodging solution providers, Airbnb does not own any hotels either! The largest and the most profitable companies of the world such as Microsoft, Google, etc. do not own any tangible assets. […]
Assumptions in Pension Fund Accounting
Accounting for pension funds is considered to be much more complex than standard accounting. This is because a lot of the payments being made in the pension funds are to be done in the distant future. Hence, as an accountant, provisions have to be made to account for these expenses as well as incomes that […]
Advantages of Non-Interest Income
Over the years, corporate banking has become a very important part of the overall banking system. This is because of the fact that banks derive a bulk of their profits from their commercial or corporate banking divisions. Now, the reason that banks derive a larger than usual percentage of their revenue from their commercial banking […]
Government Sponsored Entities
Money market securities are generally issued by firms that have a very strong credit rating. This is because investors do not want their investments to be volatile when they invest in money markets. Hence, they prefer to buy securities only from companies that have a strong credit rating. The government is the most preferable issuer […]
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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