Cash flow to capital expenditures is a financial ratio meant to measure the amount of operating cash that a company has at its disposal to invest in the company's future growth. It is calculated by taking a company's operating cash flow and dividing it by its capital expenditures, of CAPEX, which are physical assets purchased for the company. If a company's cash flow to capital expenditures ratio is on the rise, it is a sign that it is generating enough revenue to keep the company growing. As with most financial ratios, this one is best utilized to measure a company against its own past performance or to measure a company against its industry competitors.
While a company may be effective in generating revenues, it often has to turn that money over constantly to purchase physical assets. These assets may be necessary for maintenance, like a new computer bought to replace an outdated one, or they may be viewed as investments for future growth, like when a company buys a new factory or expands into another market with a new store. No matter the case, sufficient cash flow is necessary to make these purchases. This facet of the business world is highlighted by the cash flow to capital expenditures ratio.
As an example of how the cash flow to capital expenditures ratio is computed, imagine a company that has generated operational cash flow of $200,000 US Dollars (USD) over the course of a year. In that same time period, the company spent $400,000 USD on its capital expenditures. The $200,000 USD of cash flow is divided by the $400,000 USD of CAPEX, yielding a ratio of 0.5.
It is important to note that the cash flow to capital expenditures ratio is often in flux. While operational cash flow tends to be relatively steady for established companies, the CAPEX total can be skewed by a particularly large expenditure made by a company. That would cause the ratio to drop, although the revenue eventually generated from the large expenditure ideally would help the ratio rebound and even rise from its previous level.
Although the cash flow to capital expenditures ratio can be a helpful tool in showing the ability of a business to reinvest in itself, it comes with a few caveats. For one, it might not be accurate in measuring companies from different industries against one another, since some industries tend to be more capital intensive than others. In addition, newer companies tend to have lower ratios, since they are often more heavily invested in purchases intended to get the business up and running.
