Focus on cash flow

Investors timely earn returns based on a company's cash-generating ability.

Avoid investments that are not expected to generate adequate cash flow.

Cash Flow Investments

Cash-Flowing Investments
Private Equity
Hedge Funds
Alternative Strategies
Mortgages
Real Estates
High-Yield Bonds

versus

Volatile Stock Market

How to Value a Company in 3 Easy Steps

Cash Flow Statement Classifications

http://pointsandfigures.com/2010/04/26/more-on-the-dodd-bill-courtesy-of-the-oracle-of-omaha/

Investing decision: Focus on Cash Flows (FCF & Dividends) rather than Accruals (Earnings)

Investing Decisions

How much should you invest and what assets should you invest in?

Criterion:  To maximise the returns to and wealth of the investors.

The value of the firm is increased by

• cash flows generated by the firm which support the price of the stock or 
• the dividend returned to the owners.

An important characteristic of investing decision is how you approach this problem:  You should focus on the cash flows instead of accruals.

- Expenses vs. Cash Outflows

• Purchase of capital asset

- is not expense
- is cash outflow

• Recognition of depreciation expense

- is expense
- is not cash outflow

-Revenues vs Cash Inflows

• Borrowing funds

-is not revenue
- is cash inflow


Focus of cash flows:  Free Cash Flows and Dividend

rather than

Focus on accruals:  Earnings


The investing decisions by the firm typically have long term consequences to the firm over many years (3 years to 100 years). 

When investing, the investors have a projection of what the future cash inflows and future cash outflows of the firms might be but the investors cannot be certain of these future cash flows.

Therefore, the investors also need to focus on the significant risks associated with this projections of future cash flows when making their investing decision..

Cash Flow from Investing Activities

Cash flow from operations tells what cash was generated in the normal course of business and by changes in current asset and liability (working capital) accounts on the balance sheet.

• But what about cash used to invest in the business?
• Invest in other businesses?
• What about cash acquired by selling investments in other businesses?

The statement of cash flow from investing activities provides this information.

This section shows, among other things: cash used for investments in the business, including

• capital expenditures for plant, equipment, and
• other longer-term product assets.

For most growing companies, while cash flow from operations should be positive, cash flow from investing activities is often negative.

Why? Because growing companies need more physical investments - property, plant, and equipment (PP&E) - to sustain growth.

It is possible to generate positive cash flows in this part of the statement either

• by selling PP&E or
• by selling investments owned by the company.

More often than not, the total "Cash Flows from Investing Activities" is negative, and that is perfectly normal.

TIP: By comparing net cash flows from operations and net cash flows from investing activities, you can get a first glance at whether a business is productive and healthy.

If positive CFO > negative CFI, then the business produces more cash than it consumes.

But don't jump to a favourable conclusion too quickly - you may be looking at an airline (e.g. Air Asia ?) that's about to pay for five new jets in the next quarter. A surplus cash situation must be sustained to be meaningful.