One way businesses asses profitability is through their cash flow margins. You can determine how strong your sales process and products are through a calculation that takes seconds to complete.
Calculating operating cash flow margins routinely is a valuable practice for companies of all sizes. Confirming these percentages equips you to better understand how your business’s products or services become earnings and also to identify strategies for improvement.
Operating Cash Flow Margin Explained
Decision-makers rely on operating cash flow margins to gauge how capable a business is of building a profit. Calculating your business’s operating cash flow margin requires you to review operating activities.
Your business’s accounting department compiles a list of operating activities on monthly statements. Most organizations profit from selling goods and services, financing or investing. Cash flow details show executives whether their company’s offerings produce more revenue than it costs to manufacture the goods or provide services for clients.
How Are Operating Cash Flow Margins Used?
Executives should use operating cash flow margins to influence the decision-making process. Seeing how much money the offered products or services generate compared to company costs tells decision-makers when it is appropriate to develop new merchandise, hire new employees, expand marketing operations or scale efforts back.
Operating cash flow margins communicate whether your business model is feasible. When a business is unable to generate adequate profit from the merchandise or services offered, the company will struggle to repay debts. In most scenarios, the smaller a company’s operating cash flow margin is, the less profitable the brand becomes.
Temporary Operating Cash Flow Dips
Operating cash flow margins are useful for seeking out areas for potential improvement. You might notice decreasing cash flow margins, indicating a liquidity issue. A slow-falling operating cash flow margin may also signal that it is necessary to adjust the way you manage costs for production or advertising.
A temporary decrease in a business’s operating cash flow margin can level out. For example, events like expanding your company’s building or acquiring another business may result in a short-term dip. These situations do not require emergency response efforts. However, your team should investigate what exactly is causing cash flow margins to fall.
What Does a Good Cash Flow Margin Look Like?
What qualifies as an optimal cash flow margin depends on your industry. While there is no precise number all companies should strive to achieve, a solid cash flow margin ratio is generally above 50%. Your company should record a ratio of around 60% to stay profitable.
Operating Cash Flow Margin vs. Operating Margin
A business’s operating cash flow margin differs from the operating margin. A company’s operating margin comprises its amortization costs and depreciation, whereas operating cash flow margins add back expenses mentioned on an income statement. No cash transaction is necessary. The most common example of a noncash transaction is depreciation.
The operating cash flow margin is determined by dividing your operating cash flow by your company’s net sales. Calculating the operating margin requires dividing your operating income by your business’s total revenue. The operating margin measures how much money a company makes on every dollar of sales once variable costs are covered. This margin also includes the costs incurred for production, paying workers or buying raw materials.
A higher percentage ratio is ideal for both operating cash flow margins and operating margins. This number shows that a business’s operations are effective and the brand is successful at converting sales into profits.
How to Calculate Operating Cash Flow Margin
A business’s operating cash flow margin encompasses its net income, working capital, sales and noncash expenses. Find your company’s operating cash flow by adding your net income, noncash expenses and change in working capital and dividing that sum by your net sales.
Your net income is the revenue you make after subtracting expenses. Noncash expenses should include depreciation and amortization. Finally, your working capital is found by subtracting current business liabilities from the sum of any assets you have.
Use the step-by-step instructions below to use the cash flow margin formula yourself for free:
- Find the cash flow from your business’s operating activities.
- Determine your net revenue.
- Divide the operating cash flow by your net revenue.
- Take your findings and multiply the number by 100 to see the percentage.
Where to Find Increments for Your Calculation
No calculations are necessary to find the cash flow from your business’s operating activities or net revenue. These numbers appear on accounting cash flow statements and income statements. Once you’re aware of your operating cash flow margin, you can make more informed decisions and develop your next strategic plan.
Operating Cash Flow Margin Examples
Understanding cash flow margins is easier with concrete examples. If you’re new to using this free cash flow margin calculation method, review the passages below to see these strategies in practice.
Operating Cash Flow Margin Example 1
We will analyze the operating cash flow margin for Company X. In 2021, Company X made a net income of $600,000, and their noncash expenses were $30,000. The previous year, the business earned a working capital of $250,000. However, their working capital increased to $275,000, resulting in a change of $25,000. Company X showed sales of $850,000.
Company X’s operating cash flow can be calculated through the formula as follows:
- ($600,000 + $30,000 + $25,000) / $850,000 = 0.77 x 100 = 77%
As mentioned previously, Company X should strive for an operating cash flow margin of around 60% to be considered highly profitable. At 77%, Company X is doing extremely well with profits.
Operating Cash Flow Margin Example 2
This example will focus on data from Company Y. This business earned a net income of $450,000 and recorded its noncash expenses as $50,000 in 2020. For 2019, Company Y recorded a working capital of $150,000. The working capital for Company Y grew to $155,000 this year — a $5,000 increase. Company Y’s total sales made up $750,000.
The operating cash flow formula can be used for Company Y as follows:
- ($450,000 + $50,000 + $5,000) / $750,000 = 0.67 x 100 = 67%
Company Y’s operating cash flow margin is in the target area of where it should be.
Operating Cash Flow Margin Example 3
Consider these financial details from Company Z. The company recorded a net income of $300,000 and saw $100,000 in noncash expenses during 2019. Company Z noted a working capital reaching $100,000 in 2018. Company Z’s working capital was $102,000 for this year, meaning there was a $2,000 gain. Sales for the year add up to $900,000.
Note the operating cash flow for Company Z below:
- (300,000 + 100,000 + $2,000 / $900,000 = 0.47 x 100 = 47%
At 47%, the operating cash flow for Company Z could use some improvement compared to Company X and Company Y, which are both above 60%.
When to Use Cash Flow Margin Analysis
Once you calculate your cash flow margin, you can begin interpreting the results. The percentage will tell you how efficient your current business strategy is and help you determine what changes are necessary for improvement.
When your sales revenue appears consistent without frequent returns, your net profit margin is where it should be. A percentage above 60% indicates that your company is turning sales into profits and that all expenses have been addressed.
Low cash flow percentages signal a need to readjust your company’s focus. These low percentages can be temporary in cases where your business purchases new equipment, vehicles or supplies. Your company should complete routine cash flow margin analysis. The percentages you calculate show how your company is performing on a larger scale.
Ways to Potentially Improve Operating Cash Flow
Finding patterns across income statements and purchase reports is a proactive way to identify areas in which you can boost your company’s cash flow margin. Consider these methods to improve operations and keep your business profitable:
- Increase or decrease the cost of your goods or services.
- Research your options for suppliers to save money when possible.
- Provide user-friendly payment options for clients to receive your payments on time.
- Incorporate late payment penalty fees for clients who fail to pay regularly.
- Rent or lease machines or equipment to complete your daily tasks at a lower cost than buying.
- Partner with an invoice factoring company to support your business’s cash flow when you need it.
Choose Porter Capital Corporation for Invoice Factoring Services
Invoice factoring is a practical solution for businesses experiencing cash flow issues. If your business struggled while waiting for invoice payments to arrive, work with Porter Capital to receive your money within 24 hours. We buy out invoices from your clients so that you can see 85-95% of the invoice value quickly.
Whether your company needs new equipment, is short on funds to pay employees or has bills to cover, we provide funding for all the ways you do business. Our company has three decades of experience in the financial industry, so we have the expertise to eliminate obstacles and help your business grow accordingly. You can reach out to Porter Capital to get started with our invoice factoring services.