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Operating Cash to Total Cash Ratio

Evaluating the sustainability of a company's cash flows

What is the Operating Cash to Total Cash Ratio?

The Operating Cash to Total Cash Ratio measures how much a business’ generated cash flow comes from its core operations. This can be used as an indicator of how well a business can sustain its current cash management strategy in the long term.

A business that earns the bulk of its cash from its operations will likely be able to sustain its liquidity for a longer period of time. By contrast a business that earns the bulk of its cash from its financing activities may indicate that the business does not currently support a cash position that is sustainable in the long term.

The Operating Cash to Total Cash Ratio can also be used by creditors to determine the company’s creditworthiness. If the company’s already comes primarily from debt disbursements or tapping into external equity funds, the company may already have a degree of leverage that debt providers are not willing to accept. Therefore, access to debt financing for companies with a low OC to TC ratio will be more restricted since the bulk of their cash flow does not come from their operations.

 

Operating Cash to Total Cash Ratio - Summary

 

How can we calculate Operating Cash to Total Cash Ratio?

The Operating Cash to Total Cash can be calculated by dividing a business’ cash flow from operations by its net change in cash for the period. The ratio can be calculated with the following equation:

 

Operating Cash to Total Cash Ratio - Formula
Expressed as a percentage

Where:

Cash Flow from Operations – represents the amount of cash that a compnay generated over a given accounting period from its core operations. Found on the business’ cash flow statement

Net Change in Cash – refers to the total cash flows that the business has experienced for a  given accounting period. It is the sum of the cash flow from operating activities, cash flow from investing activities and cash flow from financing activities. Fond on the business’ cash flow statement.

Generally speaking, companies that are still growing may not have a lot of traction in their respective market yet; meaning that their day to day liquidity relies on alternate cash sources (such as debt or venture capital funds). However, having these sources of cash as the main/only sources are not sustainable in perpetuity as they both require a set return on investment. Conversely, a mature company will usually rely less on external capital and be able to finance its projects with the cash that it has generated from its operations.

 

Operating Cash to Total Cash Ratio Example

Tim’s Pizza wants to calculate how much of its cash comes from its operations in order to evaluate the sustainability of its cash position. Below are snippets from Tim’s financial statements:

 

Operating Cash to Total Cash Ratio  - Ex
From CFI’s Cash Flow Statement Template

 

The red boxes highlight the important information that we will need to calculate the Operating Cash to Total Cash Ratio, namely the company’s cash flow from operations and net change in cash. Using the formula provided above, we arrive at the following figures:

 

Operating Cash to Total Cash Ratio - Ex1

 

Here, we can see that Tim’s percentage o cash from operations is increasing each year. This is an indication that the business is approaching long term sustainability as it is able to generate the bulk of its cash flow from its operating activities. This may also mean that he business can begin considering debt financing to funds future NPV-positive projects in order to create more value for its shareholders. Creditors will be more inclined to lend and charge lower interest rates since they will have a higher degree of confidence with regards to the company’s ability to make periodic debt repayments.

 

To better understand the financial health of the business, the Operating Cash to Total 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, lower than Tim’s, we can conclude that Jane’s is doing a relatively good job of ratifying a sustainable long term cash strategy.

 

Additional Resources

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