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Cash Flow Reinvestment Ratio

Moneyzine Editor
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Moneyzine Editor
2 mins
January 10th, 2024
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Cash Flow Reinvestment Ratio

Definition

The term cash flow reinvestment ratio refers to a metric that allows the investor-analyst to understand the level of cash flow the company reinvests in their business. If the calculated ratio is relatively high, it can mean the company's owners are committed to growing the business.

Calculation

Cash Flow Reinvestment Ratio = Increase in Fixed Assets and Working Capital / Cash Flow (Adjusted for Dividends)

Where:

  • Cash flow adjusted for dividends is equal to net income plus non-cash expenses (such as depreciation and amortization) minus dividends.

Explanation

Cash flow measures allow the investor-analyst to understand if the company is generating enough cash flow from ongoing operations to keep the company in a financially sound position over the long term. One of the ways to understand the commitment of a company to its business is to calculate their cash flow reinvestment ratio.

By calculating a company's cash flow reinvestment ratio, the investor-analyst can understand the proportion of its cash flow the company plows back into the business in the form of new investments. If the ratio is relatively high, it can signal this type of commitment; since a large portion of its cash flow is going to investment and not being returned to shareholders. However, it may also signal the company is having difficulties raising funds elsewhere.

To gain a better understanding of how the company is performing, this metric can be used as a benchmark, comparing the company to its industry peer group.

Example

An investor is considering the purchase of Company ABC's common stock, but they would first like to gain a better understand of management's commitment to the business in terms of growth. Company ABC competes in the cloud industry, which is rapidly expanding. Given the industry, the analyst is hoping to find a ratio that is greater than 1.0, which indicates the company is not just investing all of their cash back into the business but also seeking additional monies to fund its growth.

Using Company ABC's most recent quarterly financial release, the analyst found fixed assets increased by $2,527,000, working capital increased by $1,750,000, net income was $3,023,000 non-cash expenses were $84,000, non-cash sales were $15,000 and the company paid no dividends.

Calculating the cash flow reinvestment ratio:

= ($2,527,000 + $1,750,000) / ($3,023,000 + $84,000 - $15,000)= $4,277,000 / $3,092,000), or 1.38

Since the ratio found was in excess of 1.0, the investor analyst concluded Company ABC has the potential to compete in the cloud industry and began the process of evaluating other financial metrics before purchasing shares of stock.

Related Terms

  • The term total reinvestment rate refers to a metric that allows the investor-analyst to understand how much money a company is reinvesting in itself. The calculated rate uses EBITDA in the denominator, which eliminates the effects of both financing decisions as well as accounting practices.
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  • Market Capitalization to Cash Flow Ratio
    The term market capitalization to cash flow ratio refers to a metric that allows the investor-analyst to understand the relative premium investors are willing to make in a company. The calculated rate uses EBITDA in the denominator, which eliminates the effects of both financing decisions as well as accounting practices.
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  • Cash to Net Working Capital Ratio
    The term cash to net working capital ratio refers to a metric that allows the investor-analyst to understand the amount of working capital provided by cash and liquid investments. If the calculated ratio is much less than 1.0, then the company may have trouble meeting short-term obligations due to a shortage of cash.
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  • Cash Flow to Fixed Asset Requirements Ratio
    The term cash flow to fixed assets requirements ratio refers to a metric that allows the investor-analyst to understand if a company can fund fixed assets with internally generated sources of cash. If the calculated ratio is less than 1.0, then the company will have either have to lower its planned purchase of fixed assets or seek funding from external sources.
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  • Cash Flow to Debt Payments Ratio
    The term cash flow to debt ratio refers to a metric that allows the investor-analyst to understand if a company generates enough cash flow to support their debt payments. If the calculated ratio is less than 1.0, then the company may be financially stressed since they may not be able to meet their upcoming debt obligations.
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