# Operating Cash Flow Ratio

A liquidity ratio that measures a company's ability to pay off its current liabilities with its cash flow

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## What is the Operating Cash Flow Ratio?

The Operating Cash Flow Ratio, a liquidity ratio, is a measure of how well a company can pay off its current liabilities with the cash flow generated from its core business operations. This financial metric shows how much a company earns from its operating activities, per dollar of current liabilities. Since earnings involve accruals and can be manipulated by management, the operating cash flow ratio is considered a very helpful gauge of a company’s short-term liquidity.

### Formula

The formula for calculating the operating cash flow ratio is as follows:

Where:

• Cash flow from operations can be found on a company’s statement of cash flows. Alternatively, the formula for cash flow from operations is equal to net income + non-cash expenses + changes in working capital.
• Current liabilities are obligations due within one year. Examples include short-term debt, accounts payable, and accrued liabilities.

### What is Cash Flow From Operations?

It is important to understand cash flow from operations (also called operating cash flow) – the numerator of the operating cash flow ratio.

Operating cash flow (OCF) is one of the most important numbers in a company’s accounts. It reflects the amount of cash that a business produces solely from its core business operations. Operating cash flow is intensely scrutinized by investors, as it provides vital information about the health and value of a company. If a company fails to achieve a positive OCF, the company cannot remain solvent in the long term. A negative OCF indicates that a company is not generating sufficient revenues from its core business operations, and therefore needs to generate additional positive cash flow from either financing or investment activities.

### Example of the Operating Cash Flow Ratio

The following information was taken out of Company A’s Q2 financial statements:

To calculate the ratio at the end of the second quarter:

Therefore, the company earns \$1.25 from operating activities, per dollar of current liabilities. Alternatively, it can be viewed as, “Company A can cover its current liabilities 1.25x over.”

### Interpretation of Operating Cash Flow Ratio

If the ratio is less than 1, the company generated less cash from operations than is needed to pay off its short-term liabilities. This signals short-term problems and a need for more capital. A higher ratio  – greater than 1.0 – is preferred by investors, creditors, and analysts, as it means a company can cover its current short-term liabilities and still have earnings left over. Companies with a high or uptrending operating cash flow are generally considered to be in good financial health.

### Key Takeaways

• The operating cash flow ratio is a liquidity ratio that measures how well a company can pay off its current liabilities with cash generated from its core business operations.
• This liquidity ratio is considered an accurate measure of short-term liquidity, as it only uses cash generated from core business operations rather than from all income sources.
• A ratio less than 1 indicates short-term cash flow problems; a ratio greater than 1 indicates good financial health, as it indicates cash flow more than sufficient to meet short-term financial obligations.