Cash Flow from Operations (“CFO”), found on the Cash Flow Statement, can be a powerful number to analyze the historical performance of a business. It can also provide valuable insights for future decision making, especially when combined with other financial data and used in various financial ratio calculations.
Of the three financial statements the Cash Flow Statement can often be the most overlooked and neglected – a mistake. The Balance Sheet only shows a specific point in time, and the Income Statement can have non-cash items, such as depreciation or amortization. Therefore, the Cash Flow Statement, which removes non-cash items and accounts for changes over time in the other statements, gets down to the heart of what’s important to stakeholders: cash flows and available cash.
CFO is one of three main components of a typical Cash Flow Statement, along with Cash Flow from Investing and Cash Flow from Financing. When CFO is above zero, it means core operations are generating positive cash flows – a good thing. When this happens it may mean, for example, the Company is in a position to fund various growth initiatives, pay dividends to shareholders, pay down debt, or meet a variety of other strategic objectives.
When CFO is below zero, it means a Company is losing money in its core operations and therefore must gap its negative operating cash flows from previously undistributed positive operating cash flows, or through financing and / or investing activities. In the long run, negative operating cash flows are unsustainable: if a Company wants to survive (and thrive) it must eventually make money from its operating activities.
If a Company has debt in its capital structure, understanding and analyzing cash flows is particularly important. It’s no coincidence credit ratings agencies often rely on cash flow metrics when making investment-grade or speculative-grade ratings decisions.
Below are a few important CFO metrics to keep in mind for analyzing historical performance and future decision making. Generally, CFO is found by starting with Net Income, adding non-cash expenses, and adding changes in working capital. It typically starts in the numerator in the formulas below.
| Cash Flow Ratio | Formula | What It Can Tell You |
| Cash Return on Equity | CFO / Average Shareholder Equity | Operating cash generated per dollar of equity investment |
| Cash to Income | CFO / Operating Income | Ability to generate cash from operations |
| Cash Return on Assets | CFO / Average Total Assets | Operating cash generated per dollar of asset investment |
| Dividend Payment | CFO / Dividends Paid | Ability to pay dividends from operating cash flow |
| Interest Coverage | (CFO + Interest Paid + Taxes Paid) / Interest Paid | Ability to meet interest obligations |
| Debt Coverage | (CFO – cash dividends) / Current Debt | Ability to repay current debt |
| Operating Cash Flow | CFO / Current Liabilities | Ability to generate cash to meet current liabilities |
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