Current Ratio – Formula, Meaning, Assumptions and Interpretations
The current ratio is the most popularly used metric to gauge the short term solvency of a company. This article provides the details about this ratio. Formula Current Ratio = Current Assets / Current Liabilities Meaning Current ratio measures the current assets of the company in comparison to its current liabilities. This means that the…
What are Common Size Statements ?
Common size statements are not financial ratios. Rather they are a way of presenting financial statements that makes them more suitable for analysis. However, analysts always use them in conjunction with ratio analysis. In fact, financial analysts use common size statements as the starting point to help them dig deeper. Common size statements tell them…
Introduction to Cash Flow Ratios
Once upon a time, investors and analysts used to believe in ratios that have been calculated based on the earnings that the company has stated in the Income Statement. Alas! That was once upon a time. Of late, there have been a huge number of frauds and malpractices that have come to the fore. All…
“Cash is King” say the bigwigs on Wall Street. That is why the valuation of shares is done on the basis of discounted cash flow model rather than discounted earnings model.
The price to cash flow ratio provides an analyst with a shortcut for finding companies that have been undervalued in comparison to their cash flows.
Analysts can scan through the price to cash flow ratios of a number of companies. Then they can start paying more attention to the companies where these values seem to be abnormally low. This article describes price to cash flow ratio is more detail.
There are many different measures of what analysts consider to be the true cash flow of the company. Some analysts consider operating cash flow i.e. cash flow generated from regular activities to be the correct measure. Others think that the capital investments that the company needs to make must be separated and the resultant free cash flow provides a better picture of the company’s fundamentals.
Accordingly there are at least two cash flow measures that an analyst can look at and here are their formulas:
Price to Operating Cash Flow = Current Market Price / Operating Cash Flow
Price to Free Cash Flow = Current Market Price / Free Cash Flow
The price to cash flow ratio tells the investor the number of rupees that they are paying for every rupee in cash flow that the company earns. Thus if the price to cash flow ratio is 3, then the investors are paying 3 rupees for a stream of future cash flows of 1 rupee each. This cash flow is passed on to the investors as dividend. In case, it is reinvested in the business, it shows up as capital appreciation. Thus cash flow will help the investors gain in one way or another.
Charges like depreciation, changes in inventory and revenue policy do not affect the cash position making it the favorite of skeptics.
Your email address will not be published. Required fields are marked *
