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CAPEX to Operating Cash Ratio

Assessing a business' growth strategy

What is the CAPEX to Operating Cash Ratio?

The CAPEX to Operating Cash Ratio assess how much of a company’s cash flow from operations is being devoted to capital expenditure. Such investments would entail taking part in capital-intensive projects such as expanding a production facility, launching a new product line, restructuring a division, etc…

The CAPEX to Operating Cash Ratio is a financial risk ratio that assesses how much emphasis a company is placing upon investing in capital-intensive projects. Ideally, the projects that a company chooses to pursue have shown to return a positive NPV even with worst case assumptions regarding the discount rate used, the tax rate or revenue growth rate.

The ratio is generally a good gauge to quantify how much focus on growth a company has. Typically, smaller companies that are still growing and expanding would have a higher CAPEX to Operating Cash Ratio since such businesses would be investing more in R&D. Lower ratios could indicate that a company has reached maturity and that it is no longer pursuing aggressive growth.

 

CAPEX to Operating Cash Ratio - Summary

 

How can we calculate CAPEX to Operating Cash Ratio?

The CAPEX to Operating Cash Ratio can be calculated by dividing a company’s cash flow from operations by its capital expenditures. The formula to calculate the ratio is:

 

CAPEX to Operating Cash Ratio - Formula

 

Where:

Cash flow from operations  – refers to the magnitudes of cash flows that the business generated during the accounting period, found in the statement of cash flows

Capital Expenditure – refers to investments that the business has made in pursuing growth projects. Usually an asset account found on the balance sheet that it depreciated over time.

While a high CAPEX to Operating Cash Ratio is generally a good sign for a growing company, an excessively high ratio may be sign for trouble. If a company is spending all of its cash in capital expenditure projects, it may run into liquidity issues down the road. If a company has to make periodic debt repayments or pay high fixed costs, it may be compromising its ability to make these payments if it invests too heavily in CAPEX.

Conversely, an excessively low ratio for a startup would mean that it is not investing sufficiently in R&D, which may compromise the business’ ability to grow its revenues in the long term.

 

CAPEX to Operating Cash Example

Jane’s Breads wants to calculate its CAPEX to Operating Cash Ratio in order to get assess its current focus on growth against its planned growth strategy. Below are snippets from the business’ financial statements, with the required inputs highlighted by red boxes:

 

CAPEX to Operating Cash Ratio - Ex1
From [tooltip url="https://corporatefinanceinstitute.com/resources/templates/excel-modeling/balance-sheet-template/"]CFI’s Balance Sheet Template[/tooltip]

 

CAPEX to Operating Cash Ratio - Ex2
From [tooltip url="https://corporatefinanceinstitute.com/resources/templates/excel-modeling/cash-flow-statement-template/"]CFI’s Cash Flow Statement Template[/tooltip]

Using the formula provided above, we arrive at the following figures:

 

CAPEX to Operating Cash Ratio - Ex3

 

Here, we see that Jane’s is pursuing a very aggressive growth strategy. In 2015 and 2016, Jane’s is investing more in CAPEX than it is generating cash from its operations; meaning that Jane’s is spending more than $1 in CAPEX for every dollar of operating cash generated. This is a clear indication that the business is utilizing other sources of capital such as debt, equity or retained earnings to finance its capital expansion projects. We see that the ratios are trending down over the time span displayed, which may indicated that Jane’s is slowly starting to shift focus away from growth as the business matures.

To better understand the financial health of the business, the CAPEX to Operating Cash ratio should be computed for a number of companies that operate in the same industry and compared. If some other firms operating in this industry see ratios that are, on average, higher than Jane’s, we can conclude that Jane’s is doing a relatively good job of pursuing its growth strategy.

 

Additional Resources

Thank you for reading this article! CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following resources:

  • How to Calculate Debt Service Coverage Ratio
  • Current Portion of Long-Term Debt
  • Accounting Fundamentals Course – CFI
  • Defensive Interval Ratio

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