Free Cash Flows / Operating Cash Flows Ratio

Definition

This ratio compares the free cash flows (FCF) to the operating cash flows (OCF). The more free cash flows are embedded in the operating cash flows of a company, the better it is. Higher free cash flows to operating cash flows ratio is a very good indicator of financial health of a company.

Free cash flows to a firm is a measure of potential cash flows that can be distributed to capital providers without affecting the production capacity of the firm. These are the cash flows derived form the operations of a company after subtracting working capital, investment, and taxes and represent the funds available for distribution to the capital contributors i.e. shareholders and debt providers. The idea is to provide a measure of what is available to the owners of firm after providing for capital expenditure to maintain the existing assets and to create new assets for the future growth.

The company is free to either disburse the free cash to the shareholders or use it for expansions, acquisitions, taking measures to face difficult market conditions. The expansions and acquisitions are sometimes important for future growth of the company. Sometimes expansion or acquisition is an important way to maintain competitiveness and efficiency.

Calculation (formula)

The formula for calculation of free cash flows to operating cash flows ratio is given below:

FCF/OCF Ratio = Free Cash Flows / Operating Cash Flows x 100%

The concept of free cash flows is becoming more and more popular among the investors. It has become one of the most important measures and indicators of quality of investment of a business. The calculation of free cash flows is simple and it is discussed above. The figure for operating cash flows can be found in the statement of cash flows.