Sales to Cash Flow Ratio
The sales to cash flow ratio shows how well a company generates income.
Sales to Cash Flow Ratio Details
The sales to cash flow ratio is a significant indicator of the company's overall financial health. If a company does not generate sufficient cash flow, then it will run into problems. These problems could include not paying bills, not paying off debts, trouble making payroll, and so on. If the issue with sales to cash flow is not resolved, the company could face a very dark future.
We can calculate the ratio by dividing the operating cash flows by the net sales. In the perfect world, the ratio should stay the same as sales increase, but since it's is not an ideal world, there might be changes in the ratio. If the ratio starts to decline, then there is a problem somewhere. A declining ratio could mean one of the following.
- The company is increasing sales, but it is not generating large enough cash.
- The company is allowing customers too much time to finance products. That means the cash is busy in accounts receivable and never really available for use by the company.
- The company needs to invest in more overhead as sales increase and therefore reducing the cash flow.
There is no standard as to what the sales to cash flow ratio should be. The ratio should always consistent and/or increasing as sales increase. If the ratio is constantly growing, investors will know that your company is a good investment.
Sales to Cash Flow Ratio Example
Sky, Inc. has been in business for five years and is looking to expand. However, the expansion requires help from new investors. To show prospective investors the company's financial health, Sky, Inc. calculates a monthly sales to cash flow ratio for the next two years.
At first, the ratio is doing well, but six months in, the ratio starts to decline. After a thorough review Sky, Inc. found it was allowing customers too much time to pay off the financing of a product. The company revamps the financing offers it give customers, and the sales to cash flow ratio begin to climb again.
Now investors will use more information than just the sales to cash flow ratio to decide if they should buy into the company or not. However, fixing the sales to cash flow ratio and getting it back on an increasing trend is essential.
Significance of Sales to Cash Flow Ratio
The sales to cash flow ratio is one of several indicators of how well a company is doing. If the ratio keeps going down, then the company is not generating enough money to operate. Once a company discovers a downtrend in the ratio, it needs to be fixed as quickly and efficiently as possible.
If the company doesn't fix the problem, it could mean it will eventually be out of business. Another reason the issue needs to be resolved quickly is to keep the company from the tipping point. There is a point where a company's ratio is so bad that no matter what is done, they cannot fix it.
By quickly identifying the issue, fixing it, and getting the company back on an upward trend, they save the company and a lot of jobs.