What is the ratio of cash conversion?

The ratio of cash conversion is a type of financial management tool that helps owners to understand whether the amount of income generated by the production process is sufficient due to the expenses associated with this process. The basic formula for the ratio includes the identification of the total cash flow, which results from operating efforts and related to this flow of cash from the sale for expenses that arise in the part of the production of goods that led to these sales. The company is expected to generate sufficient revenue to compensate for all net expenditures, and there are still enough remaining duties such as taxes and sending net profits for the company.

In order to determine the ratio of cash conversion, the first step is to identify cash flows generated from the sale during the specified period of time. Once this number is verified, the total production costs is required. This includes expenditures such as the cost of maintenance equipment and the operation of equipment used in the manufacturingthe process. These costs are deducted from the cash flow and leave the number, which is then divided by the amount of earnings before interest and amortization, also known as EBITA.

One of the advantages of calculating the ratio of cash conversion is that the owners of enterprises can determine how much of net profits will remain after all obligations are fulfilled. Ideally, the ratio will indicate that the company works at a sufficient level of profit to justify the continuation of operation, and perhaps enough to help gradually expand their business. If the ratio of cash conversion is somewhat low, it is a sign that some changes are necessary to continue operation, often by removing waste in the production process and at the same time trying to engage in activities intended to capture more market share and increase sales.

Theprocesis of the ratio of cash conversion ratio is also important for investors who are considering securing interest ina given business operation. If the cash flow information seems to be out of line with the sale appearing in accounting books, it may be a sign that there is some creative accounting. Given the ratio, if the ratio suggests an irregularity that is difficult to justify, the investor should move from the agreement and seek an opportunity that is supported by data that is not contrary to nature.