What Is Cash Flow Return on Investment?
Cash Flow Return on Investment (CFROI) measures the cash flow generated by a firm concerning the capital invested in the business. It indicates the company's profitability since it reveals how much cash it generates from its invested capital.
CFROI is based on cash flow, a more dependable predictor of a company's financial health than other profitability indicators focusing on earnings.
Definition 2
Cash flow return on investment (CFROI) measures corporate performance in which the numerator profits from continuing operations with fewer cash taxes and depreciation. This is divided by "cash investment," which means the replacement cost of capital employed.
More Thorough Understanding of the Term
CFROI is determined by dividing the present value of future cash flows by the amount of capital invested. The sum of the cash flows created by the company over some time, discounted to their present value using a discount rate, is the current value of cash flows.
The total amount of capital involved in the company, including debt and equity, is referred to as invested capital. CFROI can be computed for single or numerous years. When many years are present, the CFROI for each year is calculated separately and then averaged to provide the overall CFROI.
CFROI can also be used to compare the financial performance of companies in the same industry. Investors can detect which companies generate more cash flow relative to their invested capital by comparing the CFROI of different companies and which companies are more profitable and efficient.
How to Calculate CFROI?
The following formula is used to compute CFROI:
CFROI = (Present value of cash flows / Invested capital) x 100%
The present value of cash flows is computed by adding the amount of the company's cash flows over time and discounting them to their current value using a discount rate. The discount rate is typically the company's capital cost, which is the weighted average cost of debt and equity.
The total amount of capital involved in the company, including debt and equity, is referred to as invested capital. The money invested can be computed as follows:
Invested capital = Total assets - Non-interest-bearing current liabilities
Non-interest-bearing current liabilities are non-interest-bearing current liabilities, such as accounts payable, accrued expenses, and taxes payable.
Example of CFROI
Assume non-interest-bearing current obligations total $30 million. As a result, the following formula can be used to compute invested capital:
Invested capital = $100 million - $30 million = $70 million
We can now compute the CFROI using the following formula:
CFROI = ($24.86 million / $70 million) x 100% = 35.51%
This means that the company achieved a cash flow return on investment of 35.51% over the last year, considered a strong CFROI.
In Sentences
- CFROI is an effective indicator for assessing a company's financial health.
- Investors can evaluate which companies generate greater cash flow relative to their invested capital by comparing the CFROI of different companies.