What Is Operating Cash Flow Demand (OCFD)?
The term operating cash flow demand (OCFD) refers to the amount of operating cash flow an entity needs in order to meet the objectives of its strategic investments. An OCFD is integral for both investors and corporate entities. For investors, it represents the total amount of capital required in order to the desired return over the entire life of the investment. A company's OCFD, on the other hand, is used to compute the cash value added to a company's strategic investments and operations. The OCFD allows entities to make smart decisions about how they spend their money on certain investments.
- Operating cash flow demand is the amount of operating cash flow an investor needs to meet the objectives its strategic investments.
- For individual investors, the OCFD is the capital needed to achieve the desired return on investment.
- Corporations use the OCFD to compute the cash value added of their strategic investments and operations.
- Knowing the OCFD allows investors to make smart decisions about how they spend their money on certain investments.
Understanding Operating Cash Flow Demand (OCFD)
A strategic investment is any investment that allows an investor to achieve a specific goal. An individual who wants to generate a steady, risk-free stream of income may choose a bond as a strategic investment to achieve this goal. A corporation may enter a joint venture with another company as a joint venture in order to gain access to another market. All in all, strategic investment is one that fits the investor's short- or long-term game plan.
Investors need capital or operating cash flow in order to meet the initial and ongoing needs of their investments. The operating cash flow demand (OCFD), therefore, is the amount of cash flow needed for each strategic investment to have a net present value of zero, or achieve minimum profitability.
As noted above, calculating the OCFD helps entities make wiser decisions about their investments. This figure effectively helps investors decide whether to approve or reject the idea of a particular investment. If the cost of the investment is worth more than the benefit, the investor can nix the deal.
Example of Operating Cash Flow Demand (OCFD)
Let's use the hypothetical example of a manufacturing corporation to show how operating cash flow demands work. Let's say the company wants to enter a new market. In order to do so, it must make a strategic investment in a new manufacturing plant and new machinery. The OCFD for this strategic investment would be the minimum amount of cash that the plant would need to generate over its life to meet the return required by investors.
The amount of money a company expects to earn determines how much it pays for the investment. So if a company wants to earn more, it should plan to pay more for a strategic investment.
Real-World Example of Operating Cash Flow Demand (OCFD)
Now let's take a look at how operating cash flow demand works with a real-life example. This one involves GUD Holdings, an Australian company that is the corporate parent for national household brands Ryco filters, Sunbeam, Davey Pumps, Lock Focus, and others.
Ian Campbell served as the company's chief executive officer (CEO) between 1998 and 2013. At that time, the company was struggling financially. This was primarily due to a series of acquisitions the company made in an attempt to grow and boost its presence in the market. Campbell used a leadership style that combined focus and discipline. leading GUD Holdings to profitability.
Campbell expected his company manager to generate strong financial results for a key performance indicator—cash value added (CVA). This benchmark is related to OCFD. Cash value added is a measure of a company's ability to generate cash flow in excess of its investors' required return on investments (ROI) by the company.
As CEO, Campbell expected each GUD division to exceed 10% weighted average cost of capital (WACC), which is the average rate that a company is expected to pay all its security holders to finance its assets. GUD's businesses are judged on the growth in the cash value added compared to the prior year. Campbell set an annual budget for each division. The WACC varied between businesses. Managers received bonuses if they achieved their targets.