Cash Flow Return on Investment (CFROI)
Cash flow return on investment (CFROI) is the indicator that helps a firm to evaluate the performance of an investment or product. It can also be termed as the calculation that helps the stock market to set prices on the basis of cash flow.
The following formula is used to calculate it:
CFROI = Cash Flow / Market Value of Capital Employed
Cash flow return on investment can be compared with the hurdle rate which is referred to the sum of capital that is calculated by adding up the cost of debt financing and return on the equity of the investment.
It may also be referred to as the ratio that is used to measure performance which might influence the decisions of the managers regarding financial responsibilities other than depreciation and investment structures. It is the percentage rate of return of cash flow over the market value of the capital that has been employed. The calculation of Cash flow returns on investment guides a manager to target more sales by keeping the cost low and all this is achieved by making small investments.
Cash flow return on investment helps a business to determine the returns on the investment that has been made and that return must be greater than the cost of the capital. Only then the return on the investment will be positive. If the return is less than the cost of the capital then it is obvious that the Cash flow return on investment will be unfavorable. The calculations for Cash flow return on investment also include the estimated life of the company’s assets. The concept of the Cash flow return on investment also suggests that prices of stocks in the stock markets are set on the basis of cash flows rather than the earning or the performance of a business. This is something that many of us do not know.