Cash Flow to Assets

Managers accustomed to evaluating income statements usually focus on the bottom line results. While the level of cash at the bottom of the statement of cash flows is certainly an important consideration, such information could be obtained from the balance sheet.  The focal point of cash flow analysis is on cash inflows and outflows from operation activities. These cash flows are used in ratios that measure cash generating efficiency, which is a company’s ability to generate cash from its current or continuing operations. The ratios that analysts use to compute cash generating efficiency are the cash flows to sales, cash flows to assets and cash flow yield.

From this example let us compute these ratios for Jessy & Co in 2005 using the following information from the Jessy & Co 2005 annual report. (All dollar amounts are in millions)

Cash flow yield is the ratio of net cash flows from operation activities to net income:

Cash Flow Yield = Net cash Flows from operating activities / Net Income

Cash Flow Yield = 837 dollars / 669 dollars = 1.3 times

Jessy & Co’s cash flow yield of 1.3 times in 2004 means that its operating activities were generating about 30 percent more cash flow than net income. At a minimum, cash flow yield should be 1.0, which is the level typical for a service enterprise. However, a firm with significant depreciable assets should have a cash yield flow greater than 1.0 because depreciation expense id added back to net income o arrive at  cash flows from operating activities.  If special items such as discontinued operations appear on the income statement and are material, income from continuing operations should be used as the denominator.

Cash Flows to Sales are the ratio of the net cash flows from operating activities to sales:

Cash flow to sales = Net cash flows from operating activities / sales

= 837/11550 = 7.2 percent

Thus the Jessy & Co generated positive cash flows to sales of 7.2 percent in 2005

Cash flow to assets is the ratio of net cash flows from operating activities to average total assets:

Cash Flow to Assets = Net Cash Flows from operating activities / Average Total Assets

= 837/(8530/8668)/2 = 9.7 percent

Questionnaire:

• What is Cash Flow to Asset?
• How to Calculate Cash Flow Yield. Give an example.