Company managers and shareholders use various financial ratios to assess the performance of the business. Cash flow return on asset ratio measures whether a firm is efficiently using its resources to generate revenue. Managers can compare the current cash flow return on asset ratio with past ratios and other ratios to provide context.
Cash Flow Return
In calculating the cash flow return on asset ratio, you need to first figure out the current operating cash flow, which is the amount of cash the firm earns from normal operations. This means that you only include the cash revenues from the firm's core business, leaving out income from investments and other sources. From the revenues, you then need to deduct the firm's operating expenses, such as utility bills, cost of inventory and employee salaries.
Another part of the cash flow return on asset ratio is total assets, including both current and non-current assets. You can find these listed in the firm's financial statements. Current assets are those that you can convert into cash in the short term, including accounts receivable, inventories and prepaid expenses. Non-current assets include building and machinery. After adding up all the firm's assets, you obtain the total asset figure required for the calculation of the cash flow return on asset ratio.
The cash flow return on asset ratio requires a simple calculation. You only have to divide the firm's current operating cash flow from operations by its total assets. The ratio is usually expressed as a percentage. For example, if the firm has a current operating cash flow from operations of $5,000 and total assets of $50,000, then its cash flow return on asset ratio would be 10 percent (from $25,000 / $50,000).
The cash flow return on asset ratio measures how well the firm is using its assets to generate cash income from its core business activities. This ratio is a variation of the more common return on asset ratio, which also includes non-cash, non-operating return, such as account receivable from investments. Including only the cash operating return allows the firm's managers to determine whether the firm is generating enough cash to replenish its reserves and pay for its immediate expenses.