Cash flow ratios and what they show in QCE Accounting
“Calculate and interpret cash flow ratios, including the operating cash flow ratio and the cash generating power ratio, to assess liquidity and performance”
Operating cash flow ratio = net cash from operating activities / current liabilities (a cash-based liquidity test; a result above 1 means one year of operating cash covers current liabilities). Cash flow to sales = net cash from operating activities / net sales (cash earned per dollar of sales). Cash generating power = operating cash / (operating cash + cash inflows from investing + cash inflows from financing), the share of total cash inflows that came from trading rather than selling assets or borrowing. Higher is generally better, but always compare with prior years and a benchmark.
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Check against your course. The 2025 QCAA Accounting syllabus describes Unit 4 as the complete accounting processes for a trading GST business and the performance analysis of a public company, with ratios that include EBITDA, earnings per share, price earnings, dividend yield and cash flow ratios. This page covers part of that ground, so check your school's materials for the full list of what is assessed. The same ideas are also used in Unit 3 Topic 1 (cash management), which covers the purpose and classifications of the Statement of Cash Flows and the cash flow ratios.
What this dot point is asking
Ratios built from the income statement and Statement of Financial Position can look healthy while the business runs short of cash. Cash flow ratios use the Statement of Cash Flows to test liquidity and performance on a cash basis. You need to calculate them, then explain what the result means for a specific business.
The three formulas on this page follow the forms given in the QCAA Accounting formula book for the external assessment. Formula books are reissued, so check the current version before the exam and use the exact form given there.
The ratios
Operating cash flow ratio
Operating cash flow ratio = Net cash from operating activities / Current liabilities
It asks: could the business pay its current liabilities from the cash its trading generated this year? Above 1 means yes. It is a tougher and more realistic liquidity measure than the current ratio, because current assets such as inventory may never convert to cash quickly.
Cash flow to sales
Cash flow to sales = Net cash from operating activities / Net sales
It shows how many cents of operating cash each dollar of sales produces. A low or falling figure suggests sales are not converting to cash, perhaps because customers pay slowly or margins are thin.
Cash generating power
Cash generating power = Net cash from operating activities / (Net cash from operating activities + Cash inflows from investing + Cash inflows from financing)
It shows how self-sufficient the business is. A figure near 100% means almost all cash inflows came from trading. A low figure means the business is relying on selling assets or raising loans and capital to stay afloat, which cannot continue indefinitely.
Worked example
Using the Statement of Cash Flows in the previous page: net cash from operating activities $34,400; net sales $260,000; current liabilities $8,000 (the loan instalments due within a year); investing inflows $5,000 (sale of equipment, net of GST); financing inflows $30,000 (capital $10,000 plus new loan $20,000).
Operating cash flow ratio = 34,400 / 8,000 = 4.30 times.
Cash flow to sales = 34,400 / 260,000 = 13.2%.
Cash generating power = 34,400 / (34,400 + 5,000 + 30,000) = 34,400 / 69,400 = 49.6%.
Interpretation
The operating cash flow ratio of 4.30 shows trading cash is more than four times current liabilities, a strong liquidity position. Each $1 of sales produced about 13.2 cents of operating cash. Cash generating power of 49.6% shows that only about half of the year's cash inflows came from trading. The rest came from new capital and borrowing, so the business should check that it is not funding growth mainly with debt.
Interpreting the ratios properly
- Compare, do not just calculate. Compare with the previous year and an industry benchmark.
- Link to other ratios. A good current ratio but a weak operating cash flow ratio suggests current assets are tied up in slow inventory or receivables.
- Check the reason for a movement. A rise in cash generating power because the business stopped borrowing is a different story from a rise because it sold assets.
- State a decision. For example: tighten credit terms, delay a purchase, or renegotiate loan repayments.
Practice questions
1. A business has net cash from operating activities of $48,000 and current liabilities of $32,000. Calculate the operating cash flow ratio and comment.
Answer. 48,000 / 32,000 = 1.5 times. Operating cash covers current liabilities one and a half times, so the business can meet short-term debts from trading alone.
2. Operating cash $30,000, net sales $250,000. Calculate cash flow to sales.
Answer. 30,000 / 250,000 = 12%. Each dollar of sales produces 12 cents of operating cash.
3. Operating cash $20,000, investing inflows $15,000, financing inflows $25,000. Calculate cash generating power and explain what it suggests.
Answer. 20,000 / (20,000 + 15,000 + 25,000) = 20,000 / 60,000 = 33.3%. Two thirds of cash inflows came from asset sales and funding, so the business relies heavily on non-trading sources.
4. Explain why the operating cash flow ratio may be a better test of liquidity than the current ratio.
Answer. It uses cash actually generated by trading rather than the book value of current assets, some of which (inventory, prepayments) may not convert to cash soon.
- Using profit instead of operating cash
- These ratios start from the Statement of Cash Flows, not the income statement.
- Putting investing or financing outflows in the cash generating power denominator
- Only the cash inflows are used.
- Calling a high ratio automatically good
- Check why it moved and whether the business is under-investing or holding idle cash.