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What is Operating Cash Flow Margin and Why is it Important?

Posted by Dave Clarke on July 29, 2015 at 5:09 AM

Coming to grips with your company’s cash flow situation is one of the most crucial ways to measure your business’ financial health. Without adequate cash flow, you can’t expect to stay in business for too long, let alone expand and thrive. What happens when you couple cash flow with another key measurement of financial success, the sales that your business is bringing in? You get the Operating Cash Flow Margin, of course! Read on to learn the simple calculation for this important financial ratio and how it can help you better understand your business’ financial position.

 

What is the Operating Cash Flow Margin and How Do I Calculate It?

The Operating Cash Flow Margin (also called the Cash Flow Margin, or simply the Margin Ratio) is one of the most commonly used profitability ratios. It’s a measure of how much money you are generating from your operations per every dollar in sales you bring in. Put another way, it shows how efficient (or inefficient) your company is at transforming operations into cash.

 

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Armed with your cash flow report (one of the primary financial statements your business needs for successful accounting), the Operating Cash Flow Margin is simple to calculate. All you need to do is divide total cash flow from operations by net sales during a given period:


Operating Cash Flow Margin = Cash Flow from Operations / Net Sales


Although there is no one-size-fits-all ideal ratio for every company out there, as a general rule, the higher the Operating Cash Flow Margin the better. If this ratio increases over time, that’s an indication that your business is getting better and better at converting earnings from sales into actual cash flow.


How Can You Improve Your Operating Cash Flow Margin?

As we’ve seen, the Operating Cash Flow Margin is a very useful method for assessing your company’s financial health and capacity for growth. Potential investors will be paying attention to this metric to gauge the profitability and financial standing of your business compared to your competitors, so it’s worth your time to keep a close eye on it as well.


What are some ways to improve your cash flow, and thus help increase your Operating Cash Flow Margin? Shortening the payment term for your Accounts Receivable can be one way to accelerate cash inflow. (Bear in mind that you want to implement payment terms that work for your customers and your company’s finances.) Holding off on buying investments and paying Accounts Payable a bit later are both ways to preserve cash. (Be sure to avoid late payments, though, or else you may damage relationships with your creditors or incur penalties.)


Make sure to track your Operating Cash Flow Margin over time (which savvy investors will be doing too, as well as looking back at historical margins). If you see an increase in revenue from sales without an accompanying increase in cash flow, then something is wrong. Ideally, you want to see your Operating Cash Flow Margin improve over time, because that means your financial standing is improving, too!

 


Topics: Accounting