Free Cash Flow to Sales Ratio | Formula, Example, Analysis, Calculator (2024)

Free cash flow-to-sales is a performance ratio that looks into a company’s operating cash flows after subtracting all sales-relative capital expenditures. It is acrucial measurementin assessing a company’s fiscal statusand knowing its intrinsic valuation. Free cash flow-to-salesis monitored over time. You can compare it with the ratios of other companies in the same industry to better understand theimplications.

Free cash flow is crucial to the company and its shareholders. This is because this money can be used to distribute bigger dividends, bring down shares outstanding by buying back shares (hence increasing earnings per share,all else equal), or secure acquisitions to boostthe company’sgrowth prospects. How a company manages free cash flow is included in its policy for capitaldistribution.

Having more free cash flow is favorable. But how much, exactly, this should amount to? The result must be placed in context to make the free cash flow-to-sales ratio meaningful. Generally, a ratio higher than five percent is preferable.

Essentially, this indicates acompany’s robustability to pull in enough cash to keep growing. This will also serve the company well when trying to pleaseshareholders. But if such revenue all goes tocapital expenditures and leaves the company with almost no opportunitiesfor growth, then thereisn’tmuch to celebrate.

Keep inmindthatfree cash flows-to-sales have tobe monitored over adequate long-term periods. This can cover short-term periods when a company is investing aggressively as partof its growth agenda.Thus, low or negative freecash flow sales don’talways indicate problems. Rather,it could mean that the business is making heavy capital investments, preparing for an anticipated increase in future demand. The ratio may be low for one or two years, but itis expected to go upand stabilize.

Free Cash Flow To SalesFormula

This formula refers to the difference between a company’soperating cash flow and capital expenditures.All figures needed for this calculation can be found on the financial statementsof the company.

Whilethere could be minor differences in how companies computetheir free cash flows, the free cash flow-to-salesratio is often obtained by subtracting a business’capital expenditures from itsoperating cash flows. Capital expenditures areneeded everyyear to,atleast,keepan asset base and establish a foundation for expansionin the future. When operating cash flowsurpasses this kind of reinvestment, freecash flow is made.

Free Cash Flow To SalesExample

Forthe fiscal year 2019, ABC Company made a total of $200.2billionin sales. Its operatingcash flow came in at$68.1billion while its capital expenditures amounted to$5.8billion. What is ABC Company’s free cash flow-to-sales ratio?

Let’s break it down to identify the meaning and value of the different variables in this problem.

• Free cash flow-to-sales: unknown
• Free cash flow: 68,100,000 – 5,800,000 = 62,300,000
• Sales revenue: 200,200,000

In this case, ABC Company would have a free cash flow-to-sales ratio of 31.12% for 2019. The company is enjoying a very high free cash flow-to-sales ratio. This means it has a superb ability to convert its sales into cash.

In more practical terms, it shows that the company is putting a generous amount of extra cash towards growth.But like other metrics, thefree cash flow-to-sales ratioshouldn’t be reviewed alone but ratherside byside with other ratiosthatspeakof a company’s financial health. It should also be studied within a specific period instead of just a single fiscal year. This can help youto spottrends and gain more insights.

Free Cash Flow To SalesAnalysis

Free cash flow is technically money thecompany is left with after paying all its operating costs. This is what the company uses to cover its debt, distribute dividends, or reinvestinto the company’s growth. Hence, the more freecash, the better. The higher the free cash flow-to-sales ratio, themore capable a company is ofconvertingitssalesinto whatcounts the most: cash.

Keeping track of trends and comparing ratios of peers also offershints aboutthe company’s marketcompetitiveness.

If, say, a company sees that free cash flow has been going down, it should study the components of operating cash flow and review capital expenditures to get a higher ratio. If the company observes an increase while the ratio is hardly within the industry’s range, management should explore different avenues to bridge the gap.

Also, while cash-based ratios are usually more accurate, it’s a mustto notethat a business’ total free cash flow can be easily manipulated to a certain extent.

For instance, it could be tweaked to include payments made by the company which is not yet considered as cash on hand despite being spent already or cash that is yet to come in the next quarter.

When this is done simultaneously while not reporting cash outflows, the company’s free cash flow figure can end up severely over-inflated. It’s also important to note that the free cash flow-to-sales ratio is not the sole metric for assessing financial health. Alone, this ratio shouldn’t be used as more than an indicator of the need to investigate further into a business's financial position.

In other words, when seeking the sharpestpicture of a company’s fiscalhealth, it is crucial tocheck other measures aside from the free cash flow-to-sales ratio. This should include profit margin, total equity, net worth, and earnings per share.

Free Cash Flow To SalesConclusion

• The free cash flow-to-salesratio measures how much cash a company is making afterits capital expenditures.
• This formula requires two variables: free cash flow and sales revenue.
• The free cash flow-to-salesratio is usually expressed as a percentage.
• The free cash flow-to-sales ratio should be studied over some time or against the competition to get a more accurate view of the company’s efficiency.
• A higher resultindicates a greatercapability to convertsales intocash.

Free Cash Flow To SalesCalculator

You can use the free cash flow-to-salescalculator below to quickly calculate how much money a company makes after paying itscapital costs, by entering the required numbers.

FAQs

1. What is a free cash flow to sales ratio?

The free cash flow to sales ratio is a measure of how much cash a company has after its capital expenditures. This figure is expressed as a percentage.

2. What is a good free cash flow to sales ratio?

A ratio of less than 1% indicates that the company is not generating enough cash flow from its sales to cover its expenses. A ratio greater than 1% means that the company has more cash available than it spends on capital expenditures.

3. How do you interpret the cash flow to sales ratio?

The ratio can be used to measure a company's ability to generate cash flow from its sales. A higher ratio indicates that the company is more efficient in converting sales into cash. The ratio should be compared against competitors to get a more accurate understanding of the company's competitive position.

4. How do you increase the cash flow to sales ratio?

There are many ways to increase the cash flow to sales ratio. The most common way is to increase the company's sales revenue. For example, by increasing sales or expanding into new markets. Another way is to decrease the amount of money the company spends on capital expenditures.

5. How do you calculate free cash flow to sales?

The free cash flow to sales ratio is calculated by dividing the company's free cash flow by its sales revenue. This figure is expressed as a percentage. The formula is:

FCF to Sales = Free Cash Flow / Sales Revenue