This article is based on the study by Braga and Marques (2001), "Avaliação da liquidez das empresas através da análise da demonstração de fluxos de caixa" (Assessing company liquidity through the analysis of the cash flow statement), published in Revista Contabilidade & Finanças of FEA-USP.Understanding your company's cash conversion cycle is one of the main steps toward sustainable finances, which is why the metrics for analyzing cash flow are so important.Knowing that cash flow is positive, because more money comes in than goes out, is only a superficial analysis: it may indicate good financial health, but it does not guarantee it.There are further layers of analysis, such as cash flow ratios and key performance indicators (KPIs), that help business owners and entrepreneurs check whether the company will really have the money to pay its bills and to grow.The most important indicatorsLike the other financial statements, the cash flow statement (in Brazil, the DFC, Demonstração dos Fluxos de Caixa) is the basis for calculating several financial ratios. The authors group the most important ones into four categories, presented below, each aimed at one of the four objectives that SFAS No. 95 (the US cash flow standard at the time, now ASC 230) assigns to the cash flow statement. In Brazil, the cash flow statement follows CPC 03 (R2), the local pronouncement equivalent to the international standard IAS 7.In calculating these ratios, net cash flow from operations (OCF) excludes unusual transactions, such as receipts from court settlements or insurance claims, which would distort the comparison between periods.Cash coverage ratiosThe first category, the coverage ratios, makes it possible to assess the liquidity of the business: the ability of the cash generated by operations to cover interest, debt and dividends.Cash interest coverageIt complements the traditional interest coverage ratio, which uses profit (accrual basis). Since OCF is already net of the interest and income taxes paid, they are added back in the numerator. A ratio of 1.3 means that for every R$ 1.00 of interest paid, operations generated R$ 1.30 of cash.\[\frac{\text{OCF before interest and taxes}}{\text{Interest paid}}\]Cash debt coverageIt uses retained operating cash flow, that is, after dividends. The inverse of the ratio indicates how many years of cash generation would be needed to repay all the debt.\[\frac{\text{OCF} - \text{Total dividends}}{\text{Total liabilities (current + non-current)}}\]Cash dividend coverageIt shows the ability to pay dividends (including interest on equity — juros sobre capital próprio, a Brazilian form of shareholder remuneration) with the cash generated by operations.\[\frac{\text{OCF}}{\text{Total dividends}}\]A company had OCF of R$ 900 thousand, already net of R$ 100 thousand of interest paid and R$ 200 thousand of income taxes paid. What is its cash interest coverage?Answer: 12 times — the numerator is OCF before interest and taxes: 900 + 100 + 200 = 1,200; divided by interest of 100, that gives 12. Using OCF without adding back interest and taxes (900 ÷ 100 = 9) understates coverage.Quality of earnings ratiosThe second category brings together the quality of earnings ratios. One of them is the cash quality of sales, which measures the proportion of sales revenue that was converted into money during the period.Quality of sales\[\frac{\text{Cash collected from sales}}{\text{Sales revenue}}\]Since the amount collected from customers only appears in the cash flow statement under the direct method, external analysts often approximate it with OCF itself (operating cash flow to sales), as in the example below.Quality of earningsIt compares the cash generated by operations with operating income. A ratio of 0.7 means that for every R$ 1.00 of operating profit, operations generated R$ 0.70 of cash; the difference comes from items that enter profit without passing through cash, such as credit sales not yet collected and depreciation.\[\frac{\text{OCF}}{\text{Operating income}}\]A company's OCF ÷ operating income ratio came to 0.7. What is the correct reading?Answer: For every R$ 1.00 of operating profit, operations generated R$ 0.70 of cash — the difference comes from items that enter profit without passing through cash, such as uncollected credit sales. The percentage of sales collected is a different ratio, the quality of sales.Capital expenditure ratiosThe third category deals with spending on investments in productive assets.Capital acquisitionsIt indicates the ability to finance net investments in productive assets (acquisitions minus disposals of fixed assets) with the operating cash left after dividends. Above 1, operations pay for these investments on their own.\[\frac{\text{OCF} - \text{Total dividends}}{\text{Cash paid for capital investments}}\]Investing / financingIt compares the net cash used in investing with the net cash obtained from financing. It only makes sense when there is a net financing inflow (positive denominator) funding investment outflows.\[\frac{\text{Net cash flow from investing}}{\text{Net cash flow from financing}}\]A company generated OCF of R$ 500 thousand, paid R$ 100 thousand in dividends and invested R$ 800 thousand in fixed assets. What is the capital acquisitions ratio and what does it indicate?Answer: 0.5 — retained operating cash covered half of the investments, and the rest required other sources — (500 − 100) ÷ 800 = 0.5. The 0.625 comes from forgetting to subtract dividends, and even that would be below 1, meaning no full coverage.Cash flow return ratiosThe fourth category brings together cash flow per share and return on investment ratios.Cash flow per shareIt is the operating cash available to common shareholders (after the fixed dividends on preferred shares) divided by the weighted average number of common shares outstanding.\[\frac{\text{OCF} - \text{Preferred dividends}}{\text{Number of common shares}}\]Cash return on assetsIt is equivalent to the return on total investment, but on a cash basis. A ratio of 0.25 indicates that total assets generated, in the period, cash equal to 25% of their value.\[\frac{\text{OCF before interest and taxes}}{\text{Total assets}}\]Return on non-current liabilities and equityIt measures the cash return on permanent capital, the capital provided by long-term creditors and shareholders.\[\frac{\text{OCF}}{\text{Equity + Non-current liabilities}}\]Return on equity\[\frac{\text{OCF}}{\text{Equity}}\]Example with Vale (CVRD) and CEMIGThe study applied the ratios to the cash flow statements published by Companhia Vale do Rio Doce (CVRD, now Vale) and CEMIG from 1997 to 1999, a time when the cash flow statement was not yet mandatory in Brazil — it became so with Law 11,638/2007. In the table of indicators, CVRD's figures are in millions of reais and CEMIG's in thousands of reais.Vale's Cash Flow and StatementsCemig's Cash Flow and StatementsCompany IndicatorsCVRD increased the cash generated by operating activities over 1997-1999 (from 1,004 to 2,164 million), which helped raise the company's solvency. CEMIG, on the other hand, saw cash generation from operations fall in 1999. The financing activities of both companies consumed cash (net outflow), except in 1997 at CVRD, when there was a net inflow. At CEMIG, the net outflow from these activities grew more than sixfold from 1997 to 1998 (from 83.7 to 534 million), because of the sharp increase in dividends and interest on equity paid to shareholders. Investing activities had net outflows in every year, but CVRD increased these investments while CEMIG reduced them.In 1997, CVRD had an investing-to-financing ratio of 5.19 (405 ÷ 78): the cash used in investing was more than five times the cash obtained from financing. In CVRD's other years and in all of CEMIG's, the ratio adds no information, because there were net financing outflows (negative denominator). It only makes sense when financing inflows cover investing outflows.Apparently there was no need to increase borrowing, because operations generated more than enough cash. This surplus financed the part of the investments not covered by financing and also strengthened the cash balance.Be careful when reading the table of indicators: the "dividend coverage" line was calculated in the study as dividends (including interest on equity) divided by OCF, that is, it is the inverse of the formula given above and shows how much of operating cash was distributed. This percentage rose at both companies from 1997 to 1998 (CVRD: from 0.32 to 0.51; CEMIG: from 0.16 to 0.59) and fell in 1999 (0.38 and 0.47). In coverage terms (OCF ÷ dividends), this means coverage worsened in 1998 — at CVRD, from 3.1 to 2.0 times; at CEMIG, from 6.3 to 1.7 times — and improved in 1999 (2.6 and 2.1 times).Operating cash flow to sales, used as a measure of the cash quality of net operating revenue (how much of sales was converted into money), grew at CVRD (0.32, 0.42 and 0.51) and was stable and then fell at CEMIG (0.37, 0.37 and 0.20): in 1999, only about 20% of CEMIG's sales turned into operating cash. The operating cash flow to operating income ratio was stable at 1.22 at CVRD in 1997 and 1998 and rose to 1.54 in 1999. At CEMIG, it grew from 3.05 to 4.34 and then turned negative (−5.98) in 1999, because the company had an operating loss that year.The cash return on total assets was relatively stable at both companies. The highest rate, 13% (0.13), was CVRD's in 1999: the company's total assets generated operating cash equal to 13% of their value. Operating cash flow per share was calculated per lot of one thousand shares, the same basis both companies used to report earnings per share. Both showed growth in this measure from 1997 to 1998, explained by the strong cash generation of their operations: although the number of shares outstanding increased, OCF grew more than proportionally. In 1999, CVRD reached its best figure in the series (R$ 5.57 per thousand shares), while CEMIG had its worst (R$ 3.64).In the study's table, CVRD's dividend coverage line for 1998 shows 0.51, calculated as dividends ÷ OCF. What is the coverage in the sense of the formula OCF ÷ dividends?Answer: About 1.96 times — it is the inverse: 1 ÷ 0.51 ≈ 1.96 (or 1,381 ÷ 705). Reading 0.51 as coverage would make it look as if cash did not pay even half of the dividends, when in fact it paid them almost twice over.ConclusionCash flow ratios complement traditional ratios, calculated on the accrual basis, because they show whether profit is actually turning into money and whether that money is enough to pay interest, debt, dividends and investments. Like any ratio, however, they have limitations when used in isolation or over a short period: ideally, follow them as a time series and compare them with companies in the same sector. And always check how each company classified interest and dividends in its cash flow statement, because that changes OCF and, with it, all the ratios.Bibliographic reference1. Braga R, Marques JAV da C. Evaluation of company liquidity through analysis of the statement of cash flows. Rev contab finanç [Internet]. 2001 Jan;12(25):06–23. Available from: https://doi.org/10.1590/S1519-70772001000100001
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