Cash Flow Ratios
Secondly comes the 'Cash flow' ratios that are used to determine the state of a company's finances only in terms of cash.
What are Cash Flow Ratios?
Cash flow ratios are the measure to compare a company's cash flows to other elements of the financial statements. A higher level indicates a better ability to withstand declines in performance and a better ability to pay dividends to investors.
1. What is Cash Flow per Share?
Cash Flow per share is the earnings after-tax plus depreciation. This ratio acts as the measure of a company’s financial strength. Cash flow per share indicates the net cash of a company on a per share basis. Cash flow does not take into account non-cash expenses like depreciation and amortization.
The expenses related to amortization and depreciation are not actual losses paid with cash thus, re-entering them helps to keep the company’s cash flow from being artificially deflated.
This ratio is regarded as an accurate measure of the company’s financial position more than earning per share as it takes into consideration a company’s ability to generate cash. This is because cash flow is more difficult to manipulate than earning per share.
For example: - Let’s assume that during the fourth quarter, Company ABC reported cash flow of ₹40 lakhs and distributed preferred dividends worth ₹5 lakhs. During the same time frame, the company had a total of 10 lakhs shares outstanding. We calculate the company’s quarterly cash flow per share as follows:
(₹40,00,000 – ₹5,00,000) / ₹10,000,000 = 3.5
2. What is Free Cash Flow per Share?
Free cash flow simply means cash left over after accounting for operating expenses and Capital Expenditure (CAPEX). It is an important measure which shows how efficient a company is at generating cash. Investors use free cash flow to measure whether a company has enough cash after funding operations and capital expenditure to pay its investors through dividends or buyback.
Free cash flow = Operating CF – Capital Expenditure
Free cash flow per share is used to measure the company’s ability to pay back debt, buybacks, dividends and facilitate the growth of the business. This ratio can also be used to forecast future share prices. Increase in free cash flow and low share price indicates that the share price may rise. This is because the high cash flow per share means that earning per share should be high.
For example: - Let’s assume that during the fourth quarter, company ABC reported free cash flow of ₹40 lakhs. During the same time frame, the company had a total of 10 lakhs shares outstanding. We calculate the company’s quarterly cash flow per share as follows:
₹40,00,000 / 10,00,000 = ₹4