What Is Operating Cash Flow Demand (OCFD)?
Operating Cash Flow Demand (OCFD) is the amount of operating cash flow an entity needs to meet the objectives of its strategic investments. Understanding OCFD is crucial for investors and corporate entities. For investors, it determines the total capital required to achieve the desired return over the life of the investment. For corporations, OCFD helps compute the cash value added to their strategic investments and operations. OCFD is vital for making informed decisions about how to allocate funds effectively.
Key Takeaways
- OCFD refers to the operating cash flow required to meet strategic investment objectives.
- For investors, OCFD indicates the capital needed to achieve the desired return on investment.
- Corporations use OCFD to assess cash value added to their investments and operations.
- Understanding OCFD aids in making smarter investment decisions.
Understanding Operating Cash Flow Demand (OCFD)
A strategic investment aims to achieve specific goals, whether it’s an individual aiming for a steady income via bonds or a corporation entering a joint venture to access new markets. Strategic investments are aligned with short- or long-term objectives. Investors need capital or operating cash flow to fulfill these investments’ initial and ongoing needs. Hence, OCFD amounts to the necessary cash flow for each strategic investment to reach net present value zero or achieve minimum profitability.
By calculating OCFD, entities can make wiser investment decisions. The figure helps evaluate whether an investment idea should be approved or rejected. If the costs outweigh the benefits, it’s prudent to pass on the opportunity.
Example of Operating Cash Flow Demand (OCFD)
Consider the example of a hypothetical manufacturing corporation planning to enter a new market. To make this strategic move, the company needs to invest in a new manufacturing plant and machinery. The OCFD for this investment would be the minimum cash the plant needs to generate over its operational life to meet the investors’ required return. The expected revenue influences how much the company is willing to pay for this investment.
Real-World Example of Operating Cash Flow Demand (OCFD)
Let’s examine GUD Holdings, an Australian company managing several national household brands including Ryco Filters, Sunbeam, and Davey Pumps. During 1998-2013, under CEO Ian Campbell, GUD Holdings faced financial challenges after multiple acquisitions aimed to boost market presence. Campbell’s leadership, rooted in focus and discipline, steered GUD Holdings towards profitability.
Campbell emphasized generating strong financial results for key performance indicators like cash value added (CVA), which ties closely with OCFD. CVA measures a company’s capacity to generate cash flow exceeding investors’ required returns. Each GUD division was expected to surpass a 10% weighted average cost of capital (WACC). Divisions were judged by their growth in CVA compared to the previous year, receiving annual budgets and bonuses based on target achievements.
Related Terms: Operating Cash Flow, Capital, Return on Investment, Cash Flow, Strategic Investment, Minimum Profitability.
References
- Corporate Finance Institute. “Operation Cash Flow Ratio”.
- InvestingAnswers. “Operating Cash Flow Demand (OCFD)”.
- Bloomberg. “Ian Alistair Campbell”.
- Smart Company. “How to rescue a company on the ropes: the GUD story”.
