Cash Flow Return on Investment (CFROI)
A cash flow return on investment (CFROI) is a valuation metric that acts as a proxy for a company's economic return. The formula for CFROI is: CFROI = OCF / Capital Employed OCF = Operating Cash Flow Capital Employed = Total Equity + Short Term Debt + Capital Lease Obligations + Long Term Debt HOLT expanded the concept of a single project internal rate of return (IRR) versus a hurdle rate, applying a similar calculation for the whole firm, whereby all of a company's projects are run through the valuation exercise and averaged to come up with a firm-wide CFROI. The proprietary methodology removes what are believed to be distortions in a company's income statement and balance sheet, and makes adjustments for inflation, to create a clean comparison basis for historical analysis of an individual firm's value creation or destruction over time. A cash flow return on investment (CFROI) is a valuation metric that acts as a proxy for a company's economic return. Cash flow return on investment (CFROI) is a valuation metric that looks at cash flow, relative to a company's cost of capital. CFROI can be used to look at a company's performance over time or to compare a company's performance with peers in its sector.
What Is Cash Flow Return on Investment (CFROI)?
A cash flow return on investment (CFROI) is a valuation metric that acts as a proxy for a company's economic return. This return is compared to the cost of capital, or discount rate, to determine value-added potential. CFROI is defined as the average economic return on all of a company's investment projects in a given year. The return on investment (ROI) is a measure of how well an investment performs.
Understanding Cash Flow Return on Investments (CFROI)
FCFROI is a registered trademark of HOLT, a unit of Credit Suisse, the Swiss bank. HOLT Value Associates, formed in 1991, created this valuation metric, which the founders believed gave more insight into the economic return of an entire company.
The formula for CFROI is:
CFROI = OCF / Capital Employed
The proprietary methodology removes what are believed to be distortions in a company's income statement and balance sheet, and makes adjustments for inflation, to create a clean comparison basis for historical analysis of an individual firm's value creation or destruction over time. The question of whether management has employed its resources profitably can be answered by CFROI calculations.
The internal rate of return (IRR) is used in capital budgeting to predict or estimate how profitable a proposed investment might be. The hurdle rate is the smallest amount a company expects to earn when it invests in a project.
Uses of CFROI
CFROI can also be useful to compare company performance with peers that may have different financing choices. The focus on cash generation capabilities, the true underlying foundation of firm value, makes possible universal comparisons with peers, whether domiciled in the same country (i.e., same accounting standards) or abroad.
One interesting facet of CFROI for investors is the opportunity to compare the company's stock price with CFROI. If CFROI has been running high, for example, and this performance is not fully reflected in the stock price, investors may be able to take advantage of this possible mismatch of valuation.
Related terms:
Debt-Adjusted Cash Flow (DACF)
Debt-adjusted cash flow is used to analyze oil companies and represents pre-tax operating cash flow adjusted for financing expenses after taxes. read more
Discount Rate
"Discount rate" has two distinct definitions. I can refer to the interest rate that the Federal Reserve charges banks for short-term loans, but it's also used in future cash flow analysis. read more
Free Cash Flow-to-Sales
Free cash flow-to-sales is a performance ratio that measures operating cash flows after the deduction of capital expenditures relative to sales. read more
Fundamental Analysis
Fundamental analysis is a method of measuring a stock's intrinsic value. Analysts who follow this method seek out companies priced below their real worth. read more
Hurdle Rate
A hurdle rate is the minimum rate of return on a project or investment required by a manager or investor. read more
Internal Rate of Return (IRR) Rule
The internal rate of return (IRR) rule is a guideline for evaluating whether a project or investment is worth pursuing. read more
Internal Rate of Return (IRR) & Formula
The internal rate of return (IRR) is a metric used in capital budgeting to estimate the return of potential investments. read more
Peer Group
A peer group refers to individuals or entities that have certain traits in common. Learn how investors use peer groups to find good investments. read more
Return on Investment (ROI)
Return on investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency of several investments. read more