Cash Flow Return on Investment (CFROI)
What Is Cash Flow Return on Investment (CFROI)?
A cash flow return on investment (CFROI) is a valuation metric that acts as a proxy for a company's economic return. This return is compared to the cost of capital, or discount rate, to determine value-added potential. CFROI is defined as the average economic return on a company's all's investment projects in a given year. The return on investment (ROI) is a measure of how well an investment performs.
Understanding Cash Flow Return on Investments (CFROI)
FCFROI is a registered trademark of HOLT, a unit of Credit Suisse, the Swiss bank. HOLT Value Associates, shaped in 1991, made this valuation metric, which the founders accepted gave more understanding into the economic return of a whole company.
The formula for CFROI is:
CFROI = OCF/Capital Employed
Where:
- OCF = Operating Cash Flow
- Capital Employed = Total Equity + Short Term Debt + Capital Lease Obligations + Long Term Debt
HOLT expanded the concept of a single project internal rate of return (IRR) versus a hurdle rate, applying a comparative calculation for the whole firm, by which a company's all's projects are run through the valuation exercise and averaged to think of an all inclusive CFROI.
The proprietary methodology eliminates what are accepted to be mutilations in a company's income statement and balance sheet, and adapts for inflation, to make a clean comparison basis for historical analysis of an individual firm's value creation or destruction over the long haul. Whether or not management has employed its resources productively can be replied by CFROI calculations.
The internal rate of return (IRR) is utilized in capital budgeting to foresee or estimate how profitable a proposed investment may be. The hurdle rate is the littlest amount a company hopes to earn when it puts resources into a project.
Utilizations of CFROI
CFROI can likewise be valuable to compare company performance with peers that might have different financing decisions. The emphasis on cash generation capacities, the true underlying foundation of firm value, makes conceivable universal comparisons with peers, whether domiciled in a similar country (i.e., same accounting standards) or abroad.
One fascinating aspect of CFROI for investors is the opportunity to compare the company's stock price with CFROI. Assuming CFROI has been running high, for instance, and this performance isn't completely reflected in the stock price, investors might have the option to exploit this conceivable mismatch of valuation.
Highlights
- CFROI expects that the financial markets set the prices of stocks in light of a company's cash flow, as opposed to fundamentally on earnings or different metrics.
- CFROI gives investors knowledge into how a company functions internally, how the company makes cash, finances its operations, and spends its money.
- Cash flow return on investment (CFROI) is a valuation metric that glances at cash flow, relative to a company's cost of capital.
- CFROI can be utilized to take a gander at a company's performance after some time or to compare a company's performance with peers in its sector.
- The measurement is viewed as a cleaner perspective on performance, by eliminating purported twists in a company's financial outcomes. CFROI likewise considers the impact of inflation.
