Every financial institution and investor knows the importance of keeping their money as liquid as possible. However, many don’t know what exactly the Cash Reinvestment Ratio is, how to calculate it or why it’s important. This is despite the fact that the CCR is becoming more relevant by the day. As the global financial system becomes more interconnected and digital, more investors are looking to store their assets in the safest way possible. Cryptocurrencies and blockchain technology is the best way to achieve this goal, but the question is, how much cash should you invest in each?
The Cash Reinvestment Ratio is defined as the cash returned to the company by the investor, divided by the entire cash invested, divided by the total number of shares issued by the company.
This is a comprehensive guide to the calculation of the reinvestment ratio, with detailed interpretation, analysis and examples. You will learn how to apply his formula to value a business.
The cash reinvestment ratio, also known as the cash flow reinvestment ratio, is a useful indicator that measures the percentage of annual cash flow that a company reinvests in its operations.
Investors watch fluctuations in a company’s cash reinvestment ratio with interest, as it can be an indicator of its long-term goals and strategies.
According to the common view, a high cash reinvestment ratio means that the company is planning to grow significantly (think tech startups).
On the other hand, a low cash flow reinvestment ratio means that it is a mature, stable company that does not expect to grow or expand rapidly (think large manufacturing companies).
The reinvestment ratio comparison is as follows
Reinvestment ratio of cash = (increase in fixed assets + increase in current assets) / (net income + non-cash expenses – non-cash sales – dividends)
To calculate the ratio, add the increase in fixed assets to the increase in working capital and divide by net income plus non-cash expenses minus non-cash expenses for sales and dividends.
This information can easily be found in the company’s balance sheet and income statement.
Well, now let’s look at an example so you can see how easy it is to calculate this ratio.
Assume that between 2016 and 2017, the company increased its fixed assets and working capital by $80 million and $20 million, respectively.
The company also reported net income of $100 million, non-cash expenses of $50 million, non-cash income of $10 million and dividends of $20 million during the period.
If we include these figures in the equation, the reinvestment ratio is 83%.
This means that 83% of the company’s free cash flow is reinvested in the business.
In the above example, a cash flow reinvestment ratio of 83% may seem attractive to an investor, as it may indicate that the company is fully focused on itself and its operations and can therefore expect significant growth in the coming years.
It makes intuitive sense: If a company invests a significant portion of its free cash flow in its business, it is not foolish to assume that these investments will yield huge returns as the company continues to grow through these investments.
While a high reinvestment ratio may be attractive to some investors, it has its limitations.
It is true that growth-oriented start-ups have high (or even 100%) cash flow reinvestment rates in most cases.
However, poorly managed and incredibly inefficient companies can also have high reinvestment rates.
For example, a company may spend 90% of its cash on equipment and working capital. However, if management properly modernizes equipment and enters into better contracts with suppliers, this figure can be reduced to 60%.
This is a prime example of a company with a high cash flow reinvestment that is not only unprepared for strong growth, but is also poorly managed and likely to fail in the long run.
Before making investment decisions, it is therefore necessary to calculate other ratios and examine the company’s financial statements to gain a better understanding of its financial position and long-term objectives.