Cash Flow Ratio

A brief explanation of the cash flow numbers banks like to see when financing a business or a capital investment. September 27, 2008

Question
Dnyone want to try and explain how to calculate a shops cash flow ratio and give a example of where to put the number's?

Forum Responses
(Business and Management Forum)
From contributor J:
Are you referring to the quick ratio? I haven't heard of a cash flow ratio. Or are you referring to the Statement of Cash Flow?

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From the original questioner:
Not real sure. This is the cashflow ratio the bank would need for loan approval - a ratio of 1.2 or higher? Does that make any sense?

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From contributor J:
Okay, what they are wanting most likely is your quick ratio which is defined and calculated as follows:

An indicator of a company's short-term liquidity. The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets. The higher the quick ratio, the better the position of the company.

The quick ratio is calculated as:
(current assets minus inventories) divided by current liabilities. Current assets are cash, bonds, or anything else that can quickly be converted to cash. Current liabilities are any debts that are due and payable in full within one year. (Your mortgage and vehicle notes are not included).

Cabinet shops typically have a quick ratio of around 1.60 as an industry standard. All the quick ratio does is compare your liquidity to other similar companies so they can see how you stack up

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From the original questioner:
If you are buying a business, would the machinery you are buying be an asset or liability? Can you add any assets from the business you are buying?

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From contributor J:
Here goes: The answer to your question about machinery is yes and no. What I mean is that it is an asset, but it could be a liability if the machinery is not paid for. If the machinery has a note on it (example: a slider or a cnc), then you would list the value of the machine in the asset column and the amount due on the machine as a liability if the note is due in full in less than one year.

The second question has a little more vague answer; it depends on the lender. Bottom line is that your lender is wanting to make sure that in the event the business folds, they can at least break even and get their money back.

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From contributor F:
Working for a commercial finance firm, I run into this ratio all the time. The quick ratio is referring to a company's ability to pay short term obligations from working capital (accounts receivable, cash on hand, ect). The cash flow ratio I believe you are asking about refers to a company's ability to generate cash to pay term debt obligations.

"Cash Flow" is the term commonly given to a company’s net income plus non cash expenses (depreciation/amortization). The “Cash Flow Ratio” is then:
Net Income + Non Cash Expenses (depreciation/amortization)/Current Portion of Long-term Debt

Almost all bank’s/lessors like to see this ratio at about 1.5:1. This of course varies by industry, but that is definitely what the majority of lenders will be looking for. This ratio becomes very important when financing larger equipment acquisitions ($125k +) over longer terms (60-72 months).