Operating Cash Flow Margin

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What is an ‘Operating Cash Flow Margin’

Operating cash flow margin is a cash flow ratio which measures cash from operating activities as a percentage of sales revenue in a given period. Like operating margin, it is a trusted metric of a company’s profitability and efficiency, and its earnings quality.

‘Operating Cash Flow Margin’

Operating cash flow margin measures how efficiently a company converts sales into cash. It is a good indicator of earnings quality, because it only includes transactions that involve the actual transfer of money — unlike operating margin, which includes depreciation expenses — and accounts for any increase in working capital and capital expenditure that is needed to maintain production.

Because cash flow is driven by revenues, overhead and operating efficiency, cash flow trends can be very telling, especially when comparing performance to competitors in the same industry. Has operating cash flow turned negative because the company is investing in its operations to make them even more profitable? Or does the company need an injection of outside capital to buy time to continue operating in a desperate attempt to turn around the business?

Just as companies can improve operating cash flow margin, by using working capital more efficiently, they can also temporarily flatter operating cash flow margin by delaying the payment of accounts payable, chasing customers for payment or running down inventory. But if a company’s operating cash flow margin is increasing from year to year, it indicates its free cash flow is improving, as is its ability to expand its asset base and create long-term value for shareholders.

Free cash flow margin is another cash margin measure, which also takes into account capital expenditure. In capital intensive industries, with a high ratio of fixed to variable costs, a small increase in sales can lead to a large increase in operating cash flows, thanks to operational leverage.

Operating Cash Flow Margin Calculation

Operating Cash Flow = Net Income + Non-cash Expenses (Depreciation and Amortization) + Changes in Working Capital

Assuming company X recorded the following information for last year’s business activities:

Sales = $5,000,000

Depreciation = $100,000

Amortization = $125,000

Other Non-cash Expenses = $45,000

Working Capital = $1,000,000

Net Income = $2,000,000

And recorded the following information for this year’s business activities:

Sales = $5,300,000

Depreciation = $110,000

Amortization = $130,000

Other Non-cash Expenses = $55,000

Working Capital = $1,300,000

Net Income = $2,100,000

We calculate the cash flow from operating activities for the current year. In this example, that would be:

Cash Flow From Operating Activities = $2,100,00 + ($110,000 + $130,000 + $55,000) + ($1,300,000 – $1,000,000) = $2,695,000

To arrive at the operating cash flow margin, this number is divided by sales:

Operating Cash Flow Margin = $2,695,000 / $5,300,000 = 50.8%