Cash Flow is a measure of a company’s financial health. It represents the net amount of cash and cash equivalents coming into and going out of a business. In simple words, this tells how much a company is earning and how much it is spending.
Imagine a company as a big shop. This shop sells things or does tasks for people, and that’s how it makes money. Now, think about the money coming in and going out of this shop. If the shop is making more money than it’s spending, it’s like the shop’s wallet is getting fatter. That’s what we call a positive cash flow. It’s a good sign that the shop, or in our case, the company, is doing well!
Why should I check company cash flow?
Think of a company with a positive cash flow like a person with a full piggy bank. If they suddenly need money, like to pay off a loan, they can easily do it. This full piggy bank also makes people who’ve invested in the company happy because they can get more rewards. Plus, a positive cash flow means the company can spend more on things like research and development, and it can help the company grow its operations. It’s like having extra money to buy better tools or hire more people!
How should I check cash flow?
you can find company’s cash flow statement in their yearly and every three months reports. When you’re checking out this report card, there are three types of cash flow you should keep an eye on!
- Operating Cash Flow (OCF): This is cash generated from regular business operations, like selling goods or providing services. It’s a good indicator of whether a company can generate enough positive cash flow to maintain and grow its operations.
- Investing Cash Flow: This is cash used for investing in assets, as well as the proceeds from the sale of other businesses, equipment, or long-term assets.
- Financing Cash Flow: This is cash generated or spent on raising and repaying share capital and debt together with the payments of interest and dividends.
To find valuable stocks in the stock market, you can look at a company’s cash flow statement, which is one of the three main financial statements (the other two being the income statement and balance sheet). Here’s how you can read it:
- Check the Operating Cash Flow: You want this to be a positive number. It shows that the company is generating enough cash from its business operations to keep the business running without relying on outside financing.
- Look at the Investing Cash Flow: If this number is negative, it could mean the company is investing in its future growth by buying fixed assets such as property, plant, and equipment.
- Examine the Financing Cash Flow: A negative number here could mean the company is paying off debt, or making dividend payments and/or stock repurchases, which might be seen as a good sign for investors.
Let’s take an example. Suppose Company X has an operating cash flow of $5 million, investing cash flow of -$2 million (meaning it invested $2 million in long-term assets), and financing cash flow of -$1 million (meaning it paid off $1 million in liabilities). This would leave Company X with a net increase in cash and cash equivalents of $2 million ($5 million – $2 million – $1 million), indicating a strong financial position.
Remember, while cash flow is an important piece of the puzzle, it’s not the only thing to consider when evaluating a potential investment. Other factors like the company’s earnings, the Price/Earnings (P/E) ratio, and industry trends should also be considered. It’s always a good idea to consult with a financial advisor or do your own thorough research before making investment decisions.
How to compare two companies by Cash Flow?
Company A has a positive operating cash flow, indicating that it’s generating enough cash from its core business operations. It has a negative investing cash flow, showing that it’s investing in its future growth by acquiring new assets. Its financing cash flow is also negative, indicating it’s returning money to shareholders via dividends or stock buybacks, or paying down debt. These are generally good signs for investors, suggesting that Company A is financially healthy and potentially a valuable stock.
On the other hand, Company B has a negative operating cash flow, indicating it’s not generating enough cash from its core business operations. It has a positive investing cash flow, suggesting it’s selling off assets – possibly because it needs cash to cover operational costs or debts. Its financing cash flow is positive, which could mean it’s taking on more debt or issuing more stock, diluting the value for existing shareholders. These could be red flags for investors, suggesting that Company B might be facing financial difficulties.
By comparing the cash flows of these two companies, an investor might conclude that Company A is a more valuable stock to invest in than Company B.
Remember, this is a simplified example. In the real world, investors would consider many other factors, including the companies’ earnings, market conditions, industry trends, and specific financial ratios. They would also typically use more sophisticated methods to analyze the companies’ cash flows.
There are several sophisticated methods that investors use to analyze a company’s cash flow and other financial data. Here are a few examples:
- Discounted Cash Flow (DCF) Analysis: This method involves forecasting the company’s free cash flows and then discounting them to the present value using an appropriate discount rate. The result is an estimate of the company’s intrinsic value. If the intrinsic value is higher than the current market value, the stock could be undervalued.
- Cash Flow Ratios: There are several ratios that investors use to analyze a company’s cash flow data, such as the Cash Flow Margin (Cash Flow from Operations / Sales), the Operating Cash Flow Ratio (Operating Cash Flow / Current Liabilities), and the Free Cash Flow to Equity (FCFE) Ratio.
- Cash Flow Statement Analysis: This involves a detailed analysis of the company’s cash flow statement, looking at trends in operating, investing, and financing cash flows over multiple periods.
- Sensitivity Analysis: This is a method used to understand how different values of an independent variable impact a particular dependent variable under a given set of assumptions. In the context of cash flow analysis, this could involve changing variables like the discount rate or growth rate in a DCF model to see how they affect the estimated intrinsic value.
- Scenario Analysis: This involves creating various realistic scenarios of a company’s future (like best case, worst case, and most likely case) and then estimating the cash flows under each scenario. This can give investors a better understanding of the potential range of outcomes for the company’s future cash flows.
Remember, these methods require a good understanding of finance and accounting, and they involve a certain degree of uncertainty and risk. It’s always a good idea to do your own research or consult with a financial advisor before making investment decisions.
