Investors use Cash Flow Return on Investment to estimate profitability. Indicator allows to evaluate the effectiveness of the attracted capital.
Alternative names for Cash Flow Return on Investment:
- Cash Flow Return on Investment
- return on investment based on cash flow
- cash return on investment
- the ratio of inflation-adjusted cash flow from operating activity to the volume of investments.
What Does Cash Flow Return on Investment Show?
The indicator is used to analyze the efficiency of investments and helps the stock market to set the price for quality. CFROI is an instrument for performance evaluation and represents a monetary option for assessing the economic benefits of investing. It is calculated based on the internal rate of return.
CFROI shows the enterprise’s operating profitability, i.e. whether it can generate operating cash flow in the same amount as in the previous reporting period without attracting additional investments. The indicator is similar to the real internal rate of return. The method of its determining is quite complicated, since it takes into account the current value of money as well as adjustments for inflation and depreciation. The indicator also measures the effectiveness of managers who influence its value. The CFROI is valuable because it can be compared to the similar indicators of the other enterprises.
Formula of Cash Flow Return on Investment
CFROI = Gross Operating Cash Flow / Equity Capital
Attracted Capital = Current assets – Interest-free capital
Gross operating cash flow is the amount of operating cash flows over a given period.
Current assets represent the balance of working assets for an investigated period. For the correct calculation of the indicator, the amount of assets should be adjusted for the losses from inflation.
Interest-free capital is the value of assets less loan commitments.
Normative Value of Cash Flow Return on Investment
For the evaluation purposes, the indicator is compared to the weighted average cost of capital (WACC). If the value of CFROI is larger than WACC, there is an increase in investor’s profitability. If CFROI is smaller than WACC, the investor incurs losses.