In the context of DCF, what does 'cash flow conversion' refer to?

'Cash flow conversion' refers to the efficiency with which a company converts its net income into actual cash flows. This concept is crucial in the discounted cash flow (DCF) analysis, which focuses on estimating the present value of future cash flows generated by a business. A high cash flow conversion rate indicates that a company is effective at transforming its profits into cash that can be used for various purposes, such as reinvestment, reduction of debt, or distribution to shareholders.

In DCF, cash flow is a key input as it directly impacts the valuation of the company. Therefore, understanding the cash flow conversion process helps analysts gauge the liquidity and financial health of a business, which influences their projections of future cash flows. A company with high cash flow conversion is typically seen as more stable and better positioned to meet its financial obligations and invest in growth opportunities.