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
Simply divide the operating cash flow by your net sales. For example, you can calculate the cash flow margin of a firm that generated $100,000 in cash flows from operating activities and $300,000 in net sales by dividing $100,000 by $300,000 to get a cash flow margin of 33.34%.
How do you calculate operating margin margin? ›
Operating margin, also known as return on sales, is an important profitability ratio measuring revenue after covering the operating expenses of a business. Operating margin is calculated by dividing operating income by revenue.
What is operating margin with example? ›
For example, if a company had revenues of $2 million, COGS of $700,000, and administrative expenses of $500,000, its operating earnings would be $2 million - ($700,000 + $500,000) = $800,000. Its operating margin would then be $800,000 / $2 million = 40%.
What is the formula for operating cash flow example? ›
Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital.
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).
What is the formula for operating cash flow ratio? ›
The operating cash flow ratio is calculated by dividing operating cash flow by current liabilities. Operating cash flow is the cash generated by a company's normal business operations.
How do you calculate margin formula? ›
Let's put the margin meaning into a margin calculation formula:
- Margin = [(Revenue – COGS) / Revenue] X 100.
- Margin = (Gross Profit / Revenue) X 100.
- Margin = [($200 – $150) / $200] X 100.
- Margin = 25%
- Markup = [(Revenue – COGS) / COGS] X 100.
- Markup = (Gross Profit / COGS) X 100.
- Markup = [($200 – $150) / $150] X 100.
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.
Are operating margin and EBIT the same? ›
EBIT stands for “Earnings Before Interest and Taxes”, and it is not the same as “Operating Margin”. EBIT is a number used to calculate operating margin. “EBIT Margin” and “Operating Margin” are considered to be the same.
What is the difference between margin and operating margin? ›
Gross margin measures the return on the sale of goods and services, while operating margin subtracts operating expenses from the gross margin.
The operating margin is the ratio between a company's operating profit (i.e. EBIT) and revenue, expressed as a percentage. The operating profit margin, often referred to as “operating margin,” answers the question, “For each dollar of revenue generated, how much trickles down to operating income (EBIT)?”
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 do you calculate operating flow? ›
The simplest formula goes like this:
- 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.
Summary. Net Cash Flow = Total Cash Inflows – Total Cash Outflows. Learn how to use this formula and others to improve your understanding of your cash flow.
How is operating cash flow OCF defined? ›
Operating cash flow (OCF) is how much cash a company generated (or consumed) from its operating activities during a period. The OCF calculation will always include the following three components: 1) net income, 2) plus non-cash expenses, and 3) minus the net increase in net working capital.
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 do you calculate operating profit margin calculator? ›
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 profit from cash flow? ›
The following is the formula used to calculate the operating profit of a company:Operating Profit = Revenue - Operating Expenses - Cost of Goods Sold - Other Day-to-Day Expenses (e.g., depreciation, amortization, etc.)
