When using the price to cash flow profitability ratio– also abbreviated as P/CF– the price of a company is compared to the underlying cash flow. This ratio is used to determine how much a certain company is worth based on the cash flow it is able to generate.
The price to cash flow coverage ratio also shows an investor the dollar value that he or she must pay for the cash flow that’s being generated by the company – in short, the value of a company is directly proportional with the most important variable that can be found on the balance sheet, namely, cash.
The Basics of Price to Cash Flow
Most, if not all accounting statements are filled with adjustments to non-cash items, adjustments that fail to show the underlying profitability of a certain company. To fix the issue of these adjustments, we may use the cash flow statement in order to adjust the non-cash items once more and eventually get a clear picture of the underlying cash that’s being generated by a company or business.
So, the price to cash flow ratio is used to compare the current cash flow of a company with the value it has on the market, in order to determine whether the valuation is justified or not.
Naturally, if the price to cash flow ratio of your company is low, that means that your company’s potential is under-evaluated. However, keep in mind that the P/CF ratio has to be analyzed in accordance with a market, industry, and historical point of view.
The Formula of Price to Cash Flow
In order to come up with the price to cash flow ratio of your business, you can use two equations – which are fairly simple and easy to understand.
First, you can divide the share per price (price share) by the operating cash flow per share – which will result in the price to cash flow ratio. Moreover, you could also divide the market cap by the operating cash flow.
Because the market cap/share price metric shows the price at which stock is traded on the open market, these metrics– including price to cash flow– must be time stamped.
Final Statement
The investment industry is the one that uses the price to cash flow the most, as its analysts usually need and want to know the true value of a certain company, meaning a valuation that includes the cash generated from underlying operations as well.
Moreover, this cash flow analysis – in terms of price – can also help us compare different companies that activate in the same industry, without taking into account the various accounting differences of account summary.
Of course, when an analyst is calculating the price to cash flow ratio, he or she should always compare the final result with the market expectations for a sales growth. Moreover, a detailed, in-depth financial analysis is required for one to know how a certain company can boost its cash flows – or not.