Price to cash flow ratio is a very important valuation ratio. Often investor’s use this to evaluate various companies so that they could make investment.
Formula
It is calculated by dividing the current market price of the share by the cash flow per share.
Price to Cash Flow Ratio = Market price per share / Cash flow per share
Apparently, it is quite similar to the Price earnings (P/E) ratio. But, P/E ratio uses earning per share in the denominator while Price to cash flow ratio uses cash flow per share in the denominator.
The question may blur into your mind as how we can calculate cash flow per share. For this, you need to add up non cash income items in the net profit / net income to arrive at cash flow. After that just divide this figure with the total number of shares in issue.
Example
ABC has 100,000 ordinary shares of 10$ each. The current market price of the ABC share is $12. From the financial statements, it is extracted that the net profit/ net income for the year is $500,000. The depreciation and amortization expenses are $25,000 and $35,000 respectively.
Required: Calculate Price to cash flow ratio from the above information.
Solution
Cash flow for the year = Net income + Depreciation + Amortization = 500,000 + 25,000 + 35,000 = $560,000/-
Cash flow per share = Total cash flows / total number of ordinary shares = 560,000 / 100,000 = 5.6
Using,
Price to Cash Flow Ratio = Market price per share / Cash flow per share = 12 / 5.6 = 2.14
