Cash is one of the vital levers of the monetary efficiency of a firm for its equity shareholders, debt investors and other stakeholders. Let us talk about how one can evaluate the money flow management efficiency of a firm.
Let us look at the financials of Priyanka Vaishnavi Ltd (PV) for its newest monetary year: Cash from operations (CFO) Rs 12,500 crore capital expenditure Rs 5,000 crore existing liabilities Rs 6,500 crore. It does not have interest-bearing brief-term debt and the lengthy-term debt outstanding is Rs 8,000 crore and net revenue is Rs 6,250 crore.
Types of money flow
Cash flows are classified into 3 variants namely, operating money flow (money flow from operating activities or CFO), money flow from investing activities and money flow from financing activities. Among these, CFO is essential in meeting the money outflows in the day-to-day activities of a firm. A firm ought to have a positive figure for CFO to get the interest of the investors (each debt and equity). Piotroski’s F score framework gives a positive rating for a firm with a positive figure in its CFO.
Cash Flow Management Ratios: The following 4 ratios could be utilized by the young investors in evaluating the money flow management of their target firms.
CFO to Net Income
This ratio is otherwise recognized as high quality of earnings ratio. It is computed by dividing CFO by Profit After Tax (PAT or Net Income) of a firm. If CFO exceeds the net revenue, then it is thought of the firm can convert its accounting (accrual) earnings into money. Else, the firm has poor money flow management practices. For PV, it is two instances (= CFO of Rs 12,500 crore / PAT of Rs 6,250 crore), which indicates that the firm is superior in managing its money flows.
CFO to Capex
Capex refers to capital expenditure. This ratio is computed by dividing CFO by the capex of a firm. It reveals the capability of the firm in funding its capex employing its money generated from operating activities. For PV, it is 2.5 instances (CFO of Rs 12,500 crore / capex of Rs 5,000 crore). The firm is superior on this metric as it has Rs 2.5 for each and every Rs 1 in capex.
CFO to total debt
It is computed by dividing CFO by the total debt (Sum of interest bearing existing and lengthy-term debt). The ratio ought to be at least one for a wholesome firm. For PV, total debt is Rs 8,000 crore. The CFO to total debt for PV, it is 1.56 instances (CFO of Rs 12,500 crore / total debt of Rs 8,000 crore). This reflects that PV is desirable for its lenders as it has CFO at 1.5 instances of its total debt.
CFO to existing liabilities
It is calculated by dividing CFO by the existing liabilities of a firm. Higher the CFO in relation to the existing liabilities, superior is the capability of a firm in repaying its existing liabilities. For PV, it is 1.92 instances (i.e., Rs 12,500 crore/Rs 6,500 crore) which reveals that the firm is reasonably effective in honoring the payment of its existing liabilities.
If we assign a score of one on each and every parameter, then PV gets 4 out of 4 for its money flow management.
The writer is associate professor of Finance at XLRI – Xavier School of Management, Jamshedpur