The price of a company is compared to the underlying cash flow by using the Price to Cash Flow profitability ratio, also abbreviated as P/CF. Basically, this ratio is used to determine how much a certain company is worth based on the cash flow it is able to generate.
The Price to Cash Flow ratio also shows an investor the dollar value that he or she must pay for the cash flow that’s being generated by the company – in short, the value of a company is directly proportional with the most important variable that can be found on the balance sheet, namely, cash.
The Basics of Price to Cash Flow
Most, if not all accounting statements out there are filled with adjustments to non-cash items, adjustments that fail to show the underlying profitability of a certain company. To fix the issue of these adjustments, we may use the cash flow statement in order to adjust the non-cash items once more and eventually get a clear picture of the underlying cash that’s being generated by a company/ business.
So, the Price to Cash Flow ratio is used to compare the current cash flow of a company with the value it has on the market, in order to determine whether the valuation is justified or not – as easy as that!Naturally, if the Price to Cash Flow ratio of your company is low that means that your company’s potential is under evaluated. However, keep in mind that the P/CF ratio has to be analyzed in accordance with a market, industry, and historical point of view.
The Formula of Price to Cash Flow
In order to come up with the Price to Cash Flow ratio of our business, we can use two equations – which are fairly simple and easy to understand.
First, we can divide the share per price (price share) by the operating cash flow per share – which will result in the price to cash flow ratio. Moreover, we could also divide the market cap by the operating cash flow, the result being the same one as before, obviously.
As the market cap/ share price show at which price a share of stock is traded at on an open market, all of the valuation metrics – Price to Cash Flow included – must be time stamped.
The investment industry is the one that uses the Price to Cash Flow the most, as its analysts usually need and want to know the true value of a certain company, meaning a valuation that includes the cash generated from underlying operations as well.
Moreover, this cash flow analysis – in terms of price – can also help us compare different companies that activate in the same industry, without taking into account the various accounting differences.
Of course, when an analyst is calculating the Price to Cash Flow ratio, he or she should always compare the final result with the market expectations. Moreover, a detailed, in-depth financial analysis is required for one to know how a certain company can boost its cash flows – or not.