Margins and Ratios
Financial reports are notoriously difficult to decipher. All of those earnings figures and cash flow statements aren't worth the paper they're printed on if you don't know how to crunch the numbers to identify trends that inform your investment decisions.
For example, efficiency is a highly prized quality for investors. The whole fields of supply chain management and logistics are built around the idea of lean operations where products don't languish in the warehouse and sales are quickly converted to cash. A useful calculation for determining the overall efficiency of a company is called the operating cash flow margin.
Operating cash flow margin compares two numbers: the net cash from operations and net revenue from sales. You'll find net cash from operations on the statement of cash flows and net revenue from sales on the earnings report. Divide net cash from operations from net revenue from sales and you get the operating cash flow margin. The higher the figure, the better the company is at converting sales into cash.
Another good sign for investors is a company's ability to cover its short-term debts and other liabilities with available cash from core business operations. This figure is called operating cash flow ratio, but it isn't listed anywhere on a financial report. It's the investor's job to know how to find it. For this one, you start again with cash flow from operations and divide it by current liabilities. To find current liabilities, go to the company's current balance sheet and look at the top section of the liabilities column. Again, a high ratio is a good sign, since the company has enough cash from operations to stay in the black.
For lots more financial tips, take a peek at the links below.
- Basavaraj, Shruti. The Motley Fool. "Free Sailing With Free Cash Flow." January 11, 2006 (Accessed March 23, 2011.)http://www.fool.com/investing/high-growth/2006/01/11/free-sailing-with-free-cash-flow.aspx
- Investopedia. "The Essentials of Corporate Cash Flow" (Accessed March 23, 2011.)http://www.investopedia.com/articles/01/110701.asp
- Investopedia. "Non-operating Cash Flow" (Accessed March 24, 2011.)http://www.investopedia.com/terms/n/nonoperatingcashflows.asp
- Investopedia. "Operating Cash Flow" (Accessed March 23, 2011.)http://www.investopedia.com/terms/o/operatingcashflow.asp
- Investopedia. "Operating Cash Flow Margin" (Accessed March 23, 2011.)http://www.investopedia.com/terms/o/operating-cash-flow-margin.asp
- Investopedia. "Operating Cash Flow Ratio" (Accessed March 24, 2011.)http://www.investopedia.com/terms/o/ocfratio.asp
- The Motley Fool. "Foolish Fundamentals: The Cash Flow Statement." December 30, 2005 (Accessed March 23, 2011.)http://www.fool.com/investing/dividends-income/2005/12/30/foolish-fundamentals-the-cash-flow-statement.aspx
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