Understanding Cash Flow Return on Assets (CFROA) Ratio
Cash Flow Return on Assets (CFROA) is a metric that measures how efficiently a company utilizes its assets to generate operating cash flow. CFROA is helpful to assess the actual cash flow to the company's assets without being affected by net income. And it is calculated by dividing operating cash flow by total assets. It is also known as Cash Return on Assets and Asset Efficiency Ratio.
Higher CFROA is generally considered good. It shows how well the company is generating operating cash flow using its assets. Operating cash flow is the amount the company generates by its continuous operations. So, many investors used this metric to analyze how much the company's assets are productive in generating operating cash flow.
The formula to derive Cash Flow Return on Assets (CFROA)
Operating Cash Flow - It is the amount of cash the company generates from its continuous operations. And it is part of a company's
Cash Flow Statement.
Total Assets - It is the sum of assets owned by the company. Total Assets are recorded in the
Balance Sheet.
Example of CFROA: For the financial year, Hindustan Unilever limited reported operating cash flow as Rs.9163 Cr. and total asset as Rs.68757 Cr.
The value as per the formula [Cash Flow Return on Assets = (Operating Cash Flow / Total Assets) x 100] is calculated as (9163/68757) = 13.33%.
Key Highlight
Cash Flow Return on Assets (CFROA) measures how efficiently a company utilizes its assets to generate operating cash flow.
Cash Flow to Return on Assets (CFROA) is more effective for the companies that operate in capital intensive industries like Telecommunications, automobile manufacturing, steel production, oil production, and refining, etc.,
Always compare companies that operate in the same industry. As well as analyze the company historical data of 3 to 5 years for better understanding.
While looking at CFROA, the following points should also take into consideration:
A higher CFROA ratio is considered good. It indicates that the company is doing well in utilizing its assets to generate more operating cash flow.
And a low CFROA ratio indicates that the company is not efficiently managing its assets to generate operating cash flow.
The ideal range of CFROA ratio differs from industry to industry. Capital intensive companies' ratios will be low compared to the asset-light companies because they are more reliant on their fixed assets.
For some industries, a CFROA of 1% is good. Whereas, for some companies, a CFROA of 10% can be less. Capital-intensive companies like automobiles or telecommunication invest so much in assets for the production of goods and services. So their ratio will be low.
How to use CFROA effectively
Investors should look for a higher CFROA ratio. Comparing the company's CFROA with its industry peers will automatically identify whether the company is doing well compared to its competitors or not.
Always compare companies that operate in the same industry. As well as analyze the company historical data of 3 to 5 years for better understanding.
To get a more accurate analysis of the company, also use other financial metrics relative to CFROA like
Return on Assets (ROA),
Asset Turnover Ratio,
Debt to Assets,
Price to Cash Flow from Operation,
Return on Capital Employed (ROCE), etc.,
