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Fundamental Analysis

# Ratio Analysis (Part-4)

## Cash flow ratios

Cash flow ratios are one of the most reliable ratios. Cash is king and it is the life force for everything. A company that can generate better cash flows will have the capacity to withstand cyclicality and other business challenges. In terms of liquidity analysis, cash flow ratios are more reliable. If a business is not able to generate cash, then it is most likely to shut shop in future. Cash flow ratios use cash flows and other elements from the balance sheet and profit and loss account. Let us examine a few cash flow ratios

• The operating cash flow ratio- is similar to the margin ratio however instead of profits we use cash flow from operations to sales to understand how much cash is generated from sales. The higher the ratio better it is. Cash flow from operations means profit generated through the core business. It will not include other income, dividends, profit on the sale of assets or investments etc. which are part of financing activity and investing activity respectively. Also, non-cash expenses like depreciation and amortisation, loss on sale of assets or investments etc. will be excluded from the expenditure.

(Cash flow from operations (CFO) /sales) X 100

 Mar-19 Mar-20 Mar-21 Cash from operations 4 10 25 Net sales 271 264 228 Operating cash flow ratio 1% 4% 11% Industry leader 12% 17% 17%

Interpretation: The company has improved its cash flow from operations in the last two years. The operating cash flow ratio has improved from 1% in March-19 to 11% in March-21.

• The cash flow interest coverage ratio-this ratio is similar to the interest coverage ratio with a difference. Cash flow from operations is used instead of EBIT. Here as well a company that can generate higher cash is better. If the ratio is less than 1 then the risk of default is high.

Cash flow from operations (CFO) /interest paid

 Mar-19 Mar-20 Mar-21 Cash from operations 4 10 25 Interest 7 7 5 Cash flow interest coverage ratio 0.57 1.43 5.00 Industry leader 5.66 10.26 28.54

Interpretation: The company has improved its cash flow for interest coverage in the last two years. The cash flow interest coverage ratio has improved from 0.57 in March-19 to 5 in March-21. If you compare this with the interest coverage ratio, this ratio gives a better picture.

• Cash flow asset efficiency ratio- measures the cash generated from operations to total assets. This is similar to RoA. Historical comparison and comparison with a peer will help in decision making.

Cash flow from operations (CFO) /total assets

 Mar-19 Mar-20 Mar-21 Cash from operations 4 10 25 Total assets 203 18.48 13.68 Cash flow asset efficiency ratio 0.02 0.54 1.83 Industry leader 0.15 2.83 3.01

Interpretation: Improvement can be seen in the asset utilisation in the last two years. This means more cash is generated for every rupee of asset employed.

• Cash flow long term debt coverage- measures the ability of the company to pay off the debt. Again, the higher this ratio better it is.

(Cash flow from operations CFO – dividends paid) / long term debt

 Mar-19 Mar-20 Mar-21 Cash from operations 4 10 25 Less: Dividends 0 0 0 Cash flow after dividends (a) 4 10 25 Long term debt (b) 62 58 64 Cash flow long term debt coverage (a)/(b) 0.06 0.17 0.39 Industry leader 0.50 1.36 2.23

Interpretation: Improvement can be seen in this ratio as well. From 0.06 in March-19 this ratio has improved to 0.39 times. The industry leader is way ahead in this regard.

• Cash flow from operations to total cash inflows- This ratio indicates the capacity to generate cash flow from operations in comparison to the total cash inflows.

Cash flow from operations (CFO) / (CFO + inflow from investing + inflow from financing)

 Mar-19 Mar-20 Mar-21 Cash from operations (a) 4 10 25 Cash flow from investing activities (b) -3 0 -9 Cash flow from financing activities (c) -2 -14 -7 Total cash flow (a)+(b)+(c) -1 -4 9 Cash flow from operations to total cash flow (a)/[(a)+(b)+(c)] -4.00 -2.50 2.78 Industry leader 88.67 -200.00 74.20

Interpretation: This ratio indicates that the operating cash flow is almost 2.78 times the total cash flow. The cash flow from operations is used for investing and financing activities while leaving behind some cash in hand.

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