The Value of CFROI vs. Accounting Ratios
Going Beyond Accounting Ratios
Corporate financial statements can be misleading. Companies typically employ highly subjective accounting methods such as depreciation and off-balance sheet items which distort the true profitability of the firm and make traditional accounting ratios suspect.
The proprietary HOLT methodology corrects subjectivity by converting income statement and balance sheet information into a CFROI ® return, a measure that more closely approximates a company’s underlying economics. The resulting returns are objectively-based and can be viewed to assess the firm’s historical ability to create or destroy wealth over time.
How CFROI is Calculated
Typically, when companies undertake a specific project such as an acquisition or an expansion into a new business line, they prepare an economic profile that factors in the forecast amounts and timing of all cash outflows and inflows over the estimated project life. An internal rate of return can then be calculated, which is simply compared to the firm’s hurdle rate to decide whether or not to proceed with the project.
HOLT expands on this premise, applying it not merely to a specific project, but to an entire company. Like the IRR calculation of a project, the CFROI metric is a proxy for the company’s economic return.
This provides a consistent, holistic approach that can be used to compare performance across a portfolio, a market or a global universe of companies.