The cash flow to sales ratio reveals the ability of a business to generate cash flow in proportion to its sales volume. It is calculated by dividing operating cash flows by net sales. Ideally, the ratio should stay about the same as sales increase. If the ratio declines, it can be an indicator of a number of problems, such as:
- The firm is pursuing incremental sales that are generating a smaller amount of cash.
- The firm is offering incremental customers longer payment terms, so that cash is tied up in accounts receivable.
- The firm must invest in more overhead as its sales increase, thereby reducing the rate of growth in cash flow.
All of these issues can indicate that a business is growing its sales at the expense of declining cash flows.