What Is Cash Flow Return on Investment?
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 all of a company's investment projects in a given year.
Understanding Cash Flow Return on Investments (CFROI)
CFROI is a registered trademark of HOLT, a unit of Credit Suisse, the Swiss bank. HOLT Value Associates, formed in 1991, created this valuation metric, which the founders believed gave more insight into the economic return of an entire company. HOLT expanded the concept of a single project internal rate of return (IRR) versus a hurdle rate, applying a similar calculation for the whole firm, whereby all of a company's projects are run through the valuation exercise and averaged to come up with a firm-wide CFROI. The proprietary methodology removes what are believed to be distortions in a company's income statement and balance sheet, and makes adjustments for inflation, to create a clean comparison basis for historical analysis of an individual firm's value creation or destruction over time. The question of whether management has employed its resources profitably can be answered by CFROI calculations.
CFROI can also be useful to compare company performance with peers that may have different financing choices. The focus on cash generation capabilities, the true underlying foundation of firm value, makes possible universal comparisons with peers, whether domiciled in the same country (i.e., same accounting standards) or abroad. One interesting facet of CFROI for investors is the opportunity to compare the company's stock price with CFROI. If CFROI has been running high, for example, and this performance is not fully reflected in the stock price, investors may be able to take advantage of this possible mismatch of valuation.