Free Cash Flow-to-Sales
What Is Free Cash Flow-to-Sales?
Free cash flow-to-sales is a performance ratio that measures operating cash flows after the deduction of capital expenditures relative to sales. Free cash flows (FCF) is an important measurement in evaluating a company's financial condition and determining its intrinsic valuation. FCF-to-sales is followed over the long run and compared with competitors to give additional data internally to management and outside investors.
Seeing Free Cash Flow-to-Sales
However there might be slight varieties in the manner companies work out free cash flows, FCF is generally calculated as operating cash flows (OCF) less capital expenditures. Capital expenditures are required every year to keep an asset base at an exceptionally least, and to establish a groundwork for future growth. At the point when OCF surpasses this type of reinvestment into the business, the company is generating FCF.
FCF is key for the company and its shareholders since this cash can be used to pay higher dividends, repurchase shares to reduce shares outstanding (hence leading to higher [earnings per share](/essential earnings-per-share) (EPS), all else equivalent), or gain one more company to upgrade growth possibilities for the firm. How a company handles FCF is part of its capital allocation policy.
Special Considerations
Having FCF, of course, is attractive, yet the amount ought to be put in setting. This is the way the free cash flow-to-sales ratio is helpful. A higher FCF-to-sales is better than a lower one, as it shows a greater capacity of a company to transform sales into cash.
On the off chance that, for instance, a company's FCF/sales have been declining, the management team can examine the parts of operating cash flow (OCF) and reevaluate capital expenditure levels with an end goal to increase the ratio. In the event that the company sees a further developing trend yet finds its ratio trailing the industry average, management will be urged to investigate roads to close the gap.
It ought to be noticed that free cash flows-to-sales ought to be followed over adequate periods to account for short-term periods during which a company is making heavy investments for future growth. All in all, low or negative FCF-to-sales may not be guaranteed to mean that a company is encountering business challenges. All things being equal, it might demonstrate that it is in a period of critical capital investments to satisfy expected higher need for its products later on. The ratio could be stifled for a little while however at that point return to the more drawn out term trendline.
Illustration of Free Cash Flow-to-Sales
Below is a historical model that shows the calculation of free cash flow-to-sales for Apple Inc. All of the figures listed below were gotten from Apple's fiscal year 10K annual report.
Fiscal Year 2019
Apple for the fiscal year 2019 created revenue from sales of $260.2 billion, which is found at the top portion of the income statement. The company produced $69.4 billion in operating cash flow, which is found inside the "operating exercises" section of the cash flow statement (CFS) named "cash created by operating exercises".
Apple burned through $10.49 billion on capital expenditures, which is found inside the "contributing exercises" section of the CFS named "payments for acquisition of property, plant, and gear".
Below is a breakdown of the numbers and the calculation of Apple's 2019 FCF-to-Sales:
- Sales revenue: $260.2 billion
- Operating cash flow: $69.4 billion
- Capital expenditures: $10.49 billion
To begin with, work out free cash flow as follows:
- Free cash flow: $58.91 billion, calculated as $69.4 billion (operating cash flow) - $10.49 billion (capital expenditures)
Calculation of FCF-to-Sales:
- Free cash flow to sales: 22.6% or .226 calculated as $58.91 billion (free cash flow)/$260.2 billion (sales). The consequence of .226 can be duplicated by 100 to switch it over completely to a percentage.
As such, in 2019, Apple created 22.6% free cash flow for each dollar of revenue produced from the sale of its products and services. The FCF-to-sales figure doesn't give a lot of data except if we compare the number to a prior period, as displayed below.
Fiscal Year 2018
Below are Apple's numbers for the fiscal year 2018 and the calculation of FCF-to-Sales:
- Sales revenue: $265.6 billion
- Operating cash flow: $77.4 billion
- Capital expenditures: $13.3 billion
To begin with, work out free cash flow as follows:
- Free cash flow: $64.1 billion, calculated as $77.4 billion (operating cash flow) - $13.3 billion (capital expenditures)
Calculation of FCF-to-Sales:
- Free cash flow to sales: 24.1% or .241 calculated as $64.1 billion (free cash flow)/$265.6 billion (sales). The consequence of .241 can be duplicated by 100 to switch it over completely to a percentage.
As such, in 2018, 24.1% of Apple's sales were switched over completely to free cash flow, which was higher than the 22.6% FCF-to-sales in 2019. The difference in FCF-to-sales was due, in part, to Apple generating $8 billion more in operating cash flow in 2018 versus 2019.
It's important to compare these outcomes over several years to determine in the event that there's a trend while likewise computing the FCF-to-sales for Apple's competitors to measure its performance versus the industry. Similarly as with any financial ratio, no single measurement gives an all-inclusive analysis of a company's financial performance. Thus, it's best to utilize different financial ratios while directing an intensive survey of a company.
Features
- Free cash flow-to-sales is a measure to evaluate how much cash a company is generating from its sales.
- FCF-to-sales ought to be broke down after some time or relative to friends to evaluate how well the company produces cash over the long haul.
- A higher FCF-to-sales is better than lower, as it demonstrates a greater capacity of a company to transform sales into the main thing.
