Misconceptions about Personal Finance
The importance of financial planning at an individual and family level cannot be overstated. For years, people and even governments have been trying to inculcate this habit into the masses. However, they have found it difficult to do so. This is because there are several misconceptions related to personal finance, which are common among people. […]
Important Regulations in Investment Banking
Most of the investment banks in existence today have been around for several decades. For much of this time, the investment banking industry has been a haven for unprecedented growth. The industry has seen many risky practices to evolve periodically. This is why the investment banking industry has often been under the scrutiny of the […]
What is Prime Brokerage ?
History of Prime Brokerage The growth in the number of hedge funds as well as the scale of their operations quickly created the need for a special kind of intermediary that would cater to their needs. This intermediary was the “prime broker”. The prime brokerage business quickly caught the attention of many investment banks as […]
Universal Childcare: A Financial Analysis
Universal childcare is amongst the latest of government-funded programs which several Senators across America have started demanding. For instance, Senator Elizabeth Warren has been demanding that such a program be implemented in America as a part of her agenda for the 2020 Presidential elections. The rationale behind this program is that every group which cannot […]
Equity Valuation: Definition, Importance and Process
Throughout finance, one rule always holds true. The general belief is that the value of any asset or security is exactly equal to the discounted present value of all the cash flows that can be derived from it in future periods. Using this principle, one can easily value securities like debt. This is because they […]
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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