Understanding Free Cash Flow to Revenue
Free Cash Flow to Revenue is a performance ratio that measures how efficiently a company has converted its total revenue into free cash, and it is also known as Free Cash Flow to Sales. This metric is calculated by dividing Free Cash Flow (FCF) by Total Revenue.
Generally, a high free cash flow to revenue ratio is considered good. It indicates that the company is profitable and has a greater capacity of a company to turn its sales into cash. This ratio shows the percentage of sales converted into free cash flow.
The formula to derive Free Cash Flow to Revenue
Free Cash Flow -
It measures the company's financial performance and cash the company generates after accounting for cash outflows to support operations and maintain capital assets. It is calculated by subtracting operating cash and capital expenditures and found in the Cash flow statement.
Total Revenue -
It indicates how much a company's revenue is before deducting any expenses. Total revenue is found in the company's Income Statement.
Example of FCF to Revenue:
For the financial year, Cipla Limited company reported Free Cash Flow as Rs. 2068.44 Cr., And Total Revenue as Rs. 4606.45 Cr.,
The value as per the formula [Free Cash Flow to Revenue (FCF-to-Revenue) = (Free Cash Flow / Total Revenue) x 100 ] is calculated as (2068.44 / 4606.45 = 44.90% ).
Free Cash Flow to Revenue is calculated by dividing Free Cash Flow (FCF) by Total Revenue. It measures how efficiently a company has converted its total revenue into free cash.
While analyzing the company, we must check historical data to know the past performance of the company as well as its growth.
The free Cash Flow to Revenue ratio is also known as the Free Cash Flow to Sales ratio.
While analyzing FCF to Revenue ratio, always compare companies that operate in the same industry.
While looking at FCF to Revenue, the following points should also take into consideration:
Investors should look for companies with a high FCF to Revenue ratio. It indicates that the company is profitable and has a well-built set of operations. It also tells that the company is able to generate free cash smoothly and may have more opportunities for further growth and expansion. It also may show that the company can pull enough cash to grow.
A low FCF to Revenue ratio indicates that the company is struggling with converting total revenue into free cash and has weak operational performance.
But we cannot consider the low FCF to Revenue ratio as unpleasant.
It could mean that the company has heavy capital expenditure to expand its operations. Or the company is investing for growth and expansion. In this kind of scenario, the FCF to Revenue ratio will be low.
While analyzing the company, we must check historical data to know the past performance of the company as well as its growth. Some companies' FCF to Revenue ratio could be low for one year or two years. It could be due to the company investing in capital expenditure or other factors related to growth and expansion.
How to use Free Cash Flow to Revenue effectively
FCF to Revenue ratio indicates how much cash a company generates from its sales.
FCF to revenue ratio of 5% or higher is considered favorable for most industries.
A lower FCF to revenue ratio is not bad if the company is using its free cash flow for capital expenditures. And a company with a low FCF to Revenue ratio but growing for years can take into account while doing analysis.
While analyzing FCF to Revenue ratio, always compare companies that operate in the same industry. Also, look at historical data for better understanding.
By looking at a single ratio, we cannot analyze the performance of the company so, with FCF to Revenue Ratio we should look at other financial metrics like Asset Turnover Ratio
, EBITDA Margin
, Net Margin
, Accruals Ratio
||Screener at TSR
|| Strong Bullish
||Extremely High Margin
|7 to 10
|5 to 7
|| Mild Bullish
|4 to 5
|3 to 4
|| Mild Bearish
|2 to 3
||Very Low Margin
|0 to 2
|| Strong Bearish
||Extremely Low Margin
Related FCF to Revenue Screener