Loading the player...

DEFINITION of 'Free Cash Flow-To-Sales '

Free cash flow-to-sales is a performance ratio that measures operating cash flows after deduction of capital expenditures relative to sales. Free cash flows (FCF) is an important metric in assessing a company's financial condition and determining its intrinsic valuation. FCF/sales is tracked over time and compared with peers to provide further information internally to management and outside investors.

BREAKING DOWN 'Free Cash Flow-To-Sales '

Though there may be slight variations in the way companies calculate free cash flows, FCF is generally calculated as operating cash flows (OCF) less capital expenditures. Capital expenditures are required each year to maintain an asset base at a very minimum, and to lay a foundation for future growth. When OCF exceeds this type of reinvestment into the business, the company is generating FCF. FCF, in turn, is key for the company and its shareholders because this cash can be utilized to pay higher dividends, repurchase shares to reduce shares outstanding (thus leading to higher EPS, all else equal), or acquire another company to enhance growth prospects for the firm. How a company handles FCF is part of its capital allocation policy.

Having FCF, of course, is desirable, but the amount should be placed in context. This is how the free cash flow-to-sales ratio is useful. Obviously, higher FCF/sales is better than lower, as it indicates a greater capacity of a company to turn sales into what really matters — cash. But trend observation and peer comparison provide clues about its competitiveness in the market. If, for example, the company notices that FCF/sales has been on the decline, it will analyze the components of OCF and rethink capital expenditure levels in an effort to increase the ratio. If the company sees an improving trend but finds that its ratio is trailing the industry average, management will be encouraged to explore avenues to close the gap.

It should be noted that free cash flows-to-sales should be tracked over sufficient periods to account for short-term periods during which a company is making heavy investments for future growth. In other words, low or negative FCF/sales may not necessarily mean that a company is experiencing business challenges. Instead, it may indicate that it is in the middle of a period of significant capital investments to meet expected higher demand for its products in the future. The ratio could be suppressed for a year or two, but then revert to the longer-term trendline.

  1. Cash Position

    A cash position represents the amount of cash that a company, ...
  2. Price to Free Cash Flow

    Price to free cash flow is an equity valuation metric used to ...
  3. Cash Per Share

    Cash flow per share is the broadest measure of available cash ...
  4. Cash Flow

    Cash flow is the net amount of cash and cash-equivalents being ...
  5. Operating Cash Flow (OCF)

    Operating Cash Flow (or OCF) is a measure of the amount of cash ...
  6. Cash Flow From Investing Activities

    Cash flow from investing activities reports the total change ...
Related Articles
  1. Investing

    Free Cash Flow: Free, But Not Always Easy

    Free cash flow is a great gauge of corporate health, but it's not immune to accounting trickery.
  2. Trading

    How To Value Airline Stocks

    We explain what drives the stocks of airline companies and how best to assess their values.
  3. Investing

    5 must-have metrics for value investors

    In this article, we outline the five ratios that can help value investors find the most undervalued stocks in the market.
  4. Insights

    Wal-Mart’s Dividend Profile After Q4

    Wal-Mart's payout ratio has been increasing as a result of an earnings dip streak, although its FCF looks solid.
  5. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  6. Investing

    A Guide For Calculating The Dividend Payout Ratio

    Dividends are a significant contributor to total equity returns. That makes dividend payout ratios—which are key indicators of dividend sustainability—doubly important.
  7. Tech

    Cash Flow Is King: How to Keep it Running

    Why is cash flow so important, and what steps can a business take to improve it?
  8. Investing

    Your Dividend Payout: Can You Count On It?

    We go over several telling factors that can help you answer this question and avoid losses.
  1. What's the formula for calculating free cash flow?

    Free cash flow is the cash left over after a company pays for its operating expenses and capital expenditures. High free ... Read Answer >>
  2. What is the formula for calculating free cash flow in Excel?

    Find out more about free cash flow, the formula for calculating free cash flow and how to calculate a company's free cash ... Read Answer >>
  3. What are some examples of how cash flows can be manipulated or distorted?

    Cash flows can be manipulated or distorted in many ways, including changing accounts payable, misusing non-operating cash, ... Read Answer >>
  4. How should I evaluate a company with negative cash flow investing activities?

    Negative cash flow from investing activities should be evaluated since it could be a warning sign. However, it can also mean ... Read Answer >>
  5. What factors decrease cash flow from operating activities?

    Understand the types of factors that reduce cash flow from operation activities. Discover how declining net income and efficiency ... Read Answer >>
Trading Center