How to Calculate Free Cash Flows to Sales Ratio
If you’re looking to invest in a company or evaluate the financial health of a business, it’s important to understand how to calculate the free cash flows to sales ratio. This metric is used to determine the amount of free cash flow a company generates relative to its sales. In this article, we’ll take you through the steps of calculating this ratio and provide insights on how to analyze the results.
Gather Financial Statements
To calculate free cash flows to sales ratio, you will need to gather the financial statements of the company that you are analyzing. These statements include the income statement, balance sheet, and cash flow statement. It’s best to choose a company that has at least three years of financial data available to make a more accurate calculation.
Calculate Free Cash Flows
To calculate free cash flows, you will need to subtract capital expenditures from operating cash flows. The formula is as follows: Free Cash Flows = Operating Cash Flows - Capital Expenditures. Operating cash flows can be found on the cash flow statement, while capital expenditures can be found on the cash flow statement or the balance sheet.
Calculate Sales
Calculate the sales of the company by taking the revenue listed on the income statement. This number represents the total amount of money the company earned from its core operations.
Divide Free Cash Flows by Sales
To calculate the free cash flows to sales ratio, divide the free cash flows by the sales. The formula is as follows: Free Cash Flows to Sales Ratio = Free Cash Flows / Sales. This will give you a percentage that represents the amount of free cash flow generated for every dollar of sales.
Analyze the Ratio
Once you have calculated the free cash flows to sales ratio, it’s important to analyze it to see what it tells you about the company. A high ratio indicates that the company is generating a lot of free cash flow relative to its sales, which is a good sign. A low ratio may indicate that the company is struggling to generate free cash flow from its sales.
Compare to Industry Averages
After analyzing the ratio, it’s a good idea to compare it to the industry averages to see how the company stacks up against its peers. If the company’s ratio is higher than the industry average, it may be a sign that the company is performing well. If the ratio is lower than the industry average, it may indicate that the company is underperforming.
Consider Other Factors
While the free cash flows to sales ratio can be a useful metric for analyzing a company, it’s important to consider other factors as well. For example, if a company is investing heavily in new projects, it may have a lower free cash flows to sales ratio, but this may not necessarily be a bad thing if the investments are expected to pay off in the long run.
Repeat the Process
To get a more accurate picture of a company’s financial health, it’s a good idea to repeat the process for multiple years to see if the ratio is improving or declining over time.
Use in Investment Decisions
The free cash flows to sales ratio can be a helpful metric to use when making investment decisions. If a company has a high ratio, it may be a sign that the company is a good investment opportunity. However, it’s important to consider other factors as well, such as the company’s overall financial health and industry trends.
Conclusion
Calculating the free cash flows to sales ratio can be a useful tool for analyzing a company’s financial health. By gathering the necessary financial statements, calculating the ratio, and analyzing the results, investors can make more informed investment decisions.
