What Is the Operating Cash Flow Margin?
Operating cash flow margin is a cash flow ratio that measures cash from operating activities as a percentage of total 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.
Key Takeaways
- The operating cash flow margin reveals how effectively a company converts sales to cash and is a good indicator of earnings quality.
- Operating cash flow margin is calculated by dividing operating cash flow by revenue.
- This ratio uses operating cash flow, which adds back non-cash expenses.
- This is what distinguishes it from operating margin, which uses operating income that excludes such expenses as depreciation.
Understanding the 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.
Because cash flow is driven by revenues, overhead, and operating efficiency, it 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 it 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 (FCF) is improving, as is its ability to expand its asset base and create long-term value for shareholders.
Another comparison metric is the Berry ratio, which compares a company's operating expense and gross profit. It helps to remove static from the results of comparing companies operating in different states and paying different state tax rates.
Operating Cash Flow Margin vs. Operating Margin
The operating cash flow margin is unlike the operating margin. The operating margin includes depreciation and amortization expenses. However, operating cash flow margin adds back non-cash expenses, such as depreciation.
Operating margin is calculated as operating income divided by revenue. This is similar to operating cash flow margin except it uses operating income. Operating cash flow margin uses operating cash flow and not operating income.
Free cash flow margin is another cash margin measure, where it also adds in capital expenditures. 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 Example
Operating Cash Flow = Net Income + Non-cash Expenses (Depreciation and Amortization) + Change in Working Capital
Assuming company ABC recorded the following information for 2018 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 2019’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 2019 as:
- Cash Flow From Operating Activities = $2,100,000 + ($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%
Frequently Asked Questions
How does operating cash flow margin differ from operating margin?
Operating cash flow margin includes non-cash charges like depreciation and amortization. This highlights a firm's ability to turn revenues into cash flows from operations,
What are cash flows from operations?
Also called cash flows from operating activities, or abbreviated as CFO, this figure represents the amount of money flowing through a company that is related to its core business activities.
Is it better to have higher or lower operating cash flow margin?
A higher ratio is always better, as it indicates that a greater proportion of revenues are being turned into cash flows.
FAQs
Operating cash flow margin is calculated by dividing operating cash flow by revenue. This ratio uses operating cash flow, which adds back non-cash expenses. This is what distinguishes it from operating margin, which uses operating income that excludes such expenses as depreciation.
How do you calculate operating cash flow margin? ›
The operating cash flow margin is calculated by dividing cash flow from operations – i.e. operating cash flow (OCF) – by net revenue.
- Operating Cash Flow Margin = Cash Flow from Operations ÷ Net Revenue.
- Operating Cash Flow (OCF) = Net Income + Depreciation and Amortization – Increase in NWC.
Operating margin, also known as return on sales, is an important profitability ratio measuring revenue after the deduction of operating expenses. It is calculated by dividing operating income by revenue. The operating margin indicates how much of the generated sales is left when all operating expenses are paid off.
What is the formula for operating cash flow example? ›
Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital.
What is a good OCF margin? ›
A good operating cash flow margin is typically above 50%. If a company has an operating cash flow margin of below 50%, this suggests that the company is not efficiently making sales into cash, and instead, may have high expenses.
What is the formula for free cash flow margin? ›
The FCF margin formula subtracts the capital expenditure (Capex) of a company from its operating cash flow (OCF), and then divides that figure by revenue. The free cash flow metric we use here is the simplest variation, wherein a company's capital expenditures are subtracted from its operating cash flow (OCF).
How do you calculate flow through margin? ›
How to calculate flow-through. To calculate flow-through, you will be looking at the difference in profit divided by the difference in revenue. You can calculate this for any department, whether that be food and beverage, rooms or banqueting. Profit is the money you take home after all the expenses are paid off.
How to calculate operating margin in Excel? ›
The Operating Profit Margin can be easily calculated by dividing the Operating Profit, located in the income statement, by the total revenue. This margin is also known as EBIT (Earnings Before Interest and Tax) Margin.
What is the formula for operating profit? ›
The formula for calculating operating profit is Operating Profit = Revenue - Operational Expenses - Cost of Goods Sold - Day-to-Day Costs (like depreciation and amortization). Operating profit is important because it helps businesses assess their financial performance.
How to calculate operating cash flow calculator? ›
How to calculate the operating cash flow formula
- Operating cash flow = total cash received for sales - cash paid for operating expenses.
- OCF = (revenue - operating expenses) + depreciation - income taxes - change in working capital.
- OCF = net income + depreciation - change in working capital.
Here's the formula for calculating the operating cash flow ratio:Operating cash flow ratio = CFO / liabilitiesExample: A company has a CFO of $150,000 and current liabilities of $120,000 at the end of the second quarter. If you divide the company's CFO by its liabilities, its operating cash flow ratio is $1.25.
How to calculate operating cash flow margin? ›
Operating cash flow margin is calculated by dividing operating cash flow by revenue. This ratio uses operating cash flow, which adds back non-cash expenses.
What is a good operating margin? ›
A general rule of thumb is that a good operating profit margin sits between 10–20%, meaning the business has a profit of 20 cents on each dollar of revenue after operating costs have been deducted. However, this can vary from industry to industry.
What does 30% operating margin mean? ›
Expressed as a percentage, the operating margin shows how much earnings from operations is generated from every $1 in sales after accounting for the direct costs involved in earning those revenues. Larger margins mean that more of every dollar in sales is kept as profit.
How do you calculate operating profit from cash flow? ›
Operating Cash Flow Formula (OCF) = Net Income + Depreciation + Deferred Tax + Stock-oriented Compensation + non-cash items – Increase in Accounts Receivable – Increase in Inventory + Increase in Accounts Payable + Increase in Deferred Revenue + Increase in Accrued Expenses.
How do you calculate operating margin in Excel? ›
The Operating Profit Margin can be easily calculated by dividing the Operating Profit, located in the income statement, by the total revenue. This margin is also known as EBIT (Earnings Before Interest and Tax) Margin.
How do you calculate operating FCF? ›
Free Cash Flow = Cash from Operations – CapEx
It shows the cash that a company can produce after deducting the purchase of assets such as property, equipment, and other major investments from its operating cash flow.
What is the formula for operating cash flow EBIT? ›
The top-down formula to calculate the business's operating cash flow comes in three parts. Your first calculation: Sales - expenses - depreciation = EBIT. Then you use that figure for your second calculation: EBIT x tax rate = tax paid. Finally, you put it all together to get your OCF: EBIT - tax paid + depreciation.
