Operating Cash to Total Cash Ratio

What is the Operating Cash to Total Cash Ratio?

The Operating Cash to Total Cash Ratio is an important financial ratio used to measure what proportion of a company's cash flow comes from its operations.  This ratio is vital for determining the company's ability to maintain its cash management strategy over the long term.

A high operating cash-to-total cash ratio suggests that a significant portion of a company's cash flow originates from its core operational activities. 

This is a favorable sign as it indicates that the business is well-positioned to uphold its liquidity and cash management over an extended period.

Conversely, a low ratio could raise concerns. Suppose a business relies predominantly on cash inflows from financing or investing activities. In that case, it may indicate an over-dependence on non-core income streams, which can be a red flag for long-term cash sustainability.

This ratio is not just a tool for internal assessments but also holds significance for creditors. Creditors frequently employ this ratio to gauge a company's creditworthiness. 

If a company's cash flow primarily results from debt disbursements or external equity funds, it may signal a higher level of leverage. Such a scenario can affect the company's access to debt financing, especially if the majority of its cash flow is not rooted in core business operations.

How to Calculate the Operating Cash to Total Cash Ratio?

The Operating Cash to Total Cash Ratio is a critical financial metric that provides insights into a company's cash flow dynamics. To calculate this ratio, we can divide the cash flow from operations with the net change in cash for the period:

      Operating Cash to Total Cash Ratio = Cash Flow from Operations / Net Change in Cash

where,

• Cash Flow from Operations: This figure can be found in a company's cash flow statement. It represents the cash generated from its core operational activities, such as sales, services, and other business operations. This specific value from the cash flow statement is crucial to ensure accuracy.
• Net Change in Cash: This is the overall change in cash during a specific accounting period, typically a year. It encompasses cash flows from operating activities, financing activities (like loans or equity financing), and investing activities (such as buying or selling assets). You can usually locate this value in the company's statement of cash flows. 

This calculation clarifies the company's financial health and ability to maintain its cash position over the long term.

The relationship between operating cash and total cash is particularly pertinent for different types of companies. New ventures or startups may rely more on non-core income sources such as debts as they are still in the growth phase and need more market traction.

On the other hand, mature companies, having a strong footing in their respective markets, often depend less on external financing. They can finance their endeavors with cash from their core operations, making them more self-sufficient.

Operating Cash to Total Cash Ratio Example

Now that we know how to calculate this ratio, let us see how we can measure what proportion of a company's cash flow comes from its operations and thus get insights into the sustainability of the company’s current cash management strategy in the long run. 

So, let us go ahead and do the calculations for the company Microsoft. We have extracted the following financial data from the company’s annual report for 2023.

Please note that we have included only those aspects of financial reports needed to compute the operating return on assets as far as the company is concerned.

CASH FLOW STATEMENTS

(in millions USD)

Now, to determine the ratio, the organization's operating cash flow must be determined. From the above financial data:

Net cash from operations = $87,582

Now, the net change in cash and cash equivalents, which is the total of cash flows from operations, financing, and investing activities, can be determined from the above financial data:

Net change in cash and cash equivalents = $20,773

Therefore, the ratio can be calculated as follows:

       Operating Cash to Total Cash Ratio = $87,582 / $20,773 = 4.22

So, in this case, the ratio is approximately 4.22, which means that the company is generating significantly more cash from its core operations than its net cash flow.

Interpretation

The following inferences can be made based on the above financial data and the ratio calculated:

1. Significant Cash Generation 

The operating cash to total cash ratio is greater than 1 (approximately 4.22), suggesting that the company's core operations are the primary source of cash generation and mostly cover financing and investing activities.

This is a positive sign, indicating that the company's core business activities are robust and generate substantial cash flow.

2. Cash for Financing and Investing

The company has used cash in financing and investing activities, which means it may have taken on debt or made investments in assets or projects during the period. This indicates that the company is actively pursuing financing and investment opportunities.

3. Sustainable Cash Flow

The high operating cash to total cash ratio is generally a positive sign as it indicates that the company's operations generate a surplus that can be used to fund growth, pay down debt, or return value to shareholders as dividends.

Therefore, the company enjoys a healthy operating cash-to-total cash ratio, showing that its core business generates sufficient profits to cover financial and investment activities. 

Nevertheless, a more in-depth examination must be carried out to determine if the company will remain sustainable and financially healthy over the long run.

Benefits of Operating Cash to Total Cash Ratio

The Operating Cash to Total Cash Ratio, a key financial metric, offers several benefits to analysts, investors, and businesses.

Operational Efficiency 

This ratio provides valuable insights into a company's operational efficiency. It measures the proportion of cash generated from its core business operations, excluding activities like financing and investing, thereby giving insights into the company's operational efficiency.

Long-Term Viability

By focusing on cash derived from core activities, the ratio gauges a company's long-term sustainability. A high ratio indicates that the company can sustain its liquidity and operational cash management strategy over an extended period.

On the other hand, a lower ratio may signal potential issues, such as over-reliance on external funding, which can raise concerns about long-term viability.

Creditworthiness Evaluation 

Investors often use this ratio to assess a company's creditworthiness. A higher ratio suggests that a substantial portion of the company's cash flows originates from its core operations. 

This, in turn, can enhance its capacity to secure debt financing as it reflects a lower reliance on external funding. A strong ratio can translate into better access to credit markets and potentially lower borrowing costs for businesses.

Early Warning Signal 

A declining Operating Cash to Total Cash Ratio trend can be an early warning signal. It indicates a shift towards relying more on external financing or non-core business activities, which can increase financial instability. 

Companies experiencing such trends may need to reevaluate their financial strategies and work towards a more sustainable balance between core operations and other cash sources.

Strategic Decision-Making

This ratio is a valuable tool for businesses to make strategic decisions. Management teams can use it to assess their reliance on external financing, take necessary steps to improve operational efficiency and reduce the need for non-core cash sources. 

Conclusion

The Operating Cash to Total Cash Ratio wraps a crucial snapshot of a company's cash management. This metric illuminates how much of a company's cash comes from its operations relative to the total cash reserves. 

A higher ratio often signals efficient cash generation from core business activities, portraying financial health. On the other hand, a low ratio might hint at potential liquidity issues or overreliance on external financing.

However, it's not a standalone verdict. Industries vary, and so do their cash dynamics. Comparing ratios within the same sector allows for more meaningful insights. 

Additionally, examining trends over time reveals shifts in a company's ability to generate cash from core operating activities.

So, it's a piece of the financial puzzle, providing invaluable cues for investors and analysts navigating the intricate landscape of cash flow analysis. 

Researched and authored by Sauryan Pandey | LinkedIn

Reviewed and edited by Parul Gupta | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Idle Cash
• Operating Asset Turnover Ratio
• Operating Cash to Debt Ratio
• Operating Return on Assets (OROA)
• Operating Risk