The distinction between Profit and Cash. A business can be profitable but short of cash.

Cash is completely different from profit, a fact that is not always properly appreciated.

It is possible, and indeed quite common, for a business to be profitable but short of cash.

Among the differences are the following:

1. Money may be collected from customers more slowly (or more quickly) than money is paid to suppliers.
2. Capital expenditure (unless financed by hire purchase or similar means) has an immediate impact on cash.  The effect on profit, by means of depreciation, is spread over a number of years.
3. Taxation, dividends and other payments to owners are an appropriation of profit.  Cash is taken out of the business which may be more or less than the profit.
4. An expanding business will have to spend money on materials, items for sale, wages, etc. before it completes the extra sales and gets paid.  Purchases and expenses come first.  Sales and profit come later.

Cash Flow Statement

There are sometimes disputes about the figures in the Profit and Loss Account and Balance Sheet.

This is one reason why cash is so important.  

Cash is much more a matter of fact rather than of opinion.

It is either there or it is not there.

Whether the cash came from (banks, shareholders, customers) is also a matter of fact.

So too is where the cash went to (dividends, wages, suppliers, etc.).

The Cash Flow Statement gives all this information.

How do you identify an exceptional company with a durable competitive advantage from the CASH FLOW STATEMENTS?

How do you identify an exceptional company with a durable competitive advantage?

Financial statements are where you can search for companies with a durable competitive advantage that is going to make one super rich.

CASH FLOW STATEMENTS

The cash flow statement keeps track of the actual cash that flows in and out of the business.

A company can have a lot of cash coming in, through the sale of shares or bonds and still not be profitable.

A company can be profitable with a lot of sales on credit and not a lot of cash coming in.

The cash flow statement will tell us if the company is bringing in more cash than it is spending (“positive cash flow”) or if it is spending more cash than it is bringing in (“negative cash flow”).

Cash flow statements like income statements cover a set period of time.

The cash flow statement has three sections:

·               Cash flow from operating activities

·              Cash flow from investing activities

·              Cash flow from financing activities

Cash flow from operating activities

Net income + depreciation & amortization = Total Cash from Operating Activities

Depreciation and amortization are real expenses from an accounting point of view.

They don't use up any cash because they represent cash that was spent years ago.

Cash flow from investing activities

This area includes an entry for all capital expenditures made for that accounting period.

Capital expenditure is always a negative number because it is an expenditure which causes a depletion of cash.

Total Other Investing Cash Flow Items adds up all the cash that gets expended and brought in, from the buying and selling of income producing assets.

If more cash is expended than is brought in, it is a negative number.

If more cash is brought in than is expended, it is a positive number.

Capital Expenditure + Other Investing Cash Flow Items = Total Cash from Investing Activities

Cash flow from financing activities

This measures the cash that flows in and out of a company because of financing activities.

This includes all outflows of cash for the payment of dividends.

It also includes the selling and buying of the company’s stock.

When the company sells shares to finance a new plant, cash flows into the company.

When the company buys back its shares, cash flows out of the company.

The same thing happens with bonds.

Sell a bond and cash flows in; buy back a bond and cash flows out.

Cash Dividends Paid + Issuance (Retirement) of Stock, Net + Issuance (Retirement) of Debt, Net  = Total Cash from Financing Activities

Net Change in Cash

Total Cash from Operating Activities + Total Cash from Investing Activities + Total Cash from Financing Activities = Net Change in Cash

Some of the information found on a company’s cash flow statement can be very useful in helping us determine whether or not the company in question is benefiting from having a durable competitive advantage.

Capital Expenditures

Capital expenditures are outlays of cash or the equivalent in assets that are more permanent in nature – held longer than a year – such as property, plant and equipment.

They also include expenditures for such intangibles as patents.

They are assets that are expensed over a period of time greater than a year through depreciation and amortization.

Capital expenditures are recorded on the cash flow statement under investment operations.

When it comes to making capital expenditures, not all companies are created equal.

Many companies must make huge capital expenditures just to stay in business.

If the capital expenditures remain high over a number of years, they can start to have deep impact on earnings.

As a rule, a company with durable competitive advantage uses a smaller portion of its earnings for capital expenditures for continuing operations than do those without a competitive advantage.

Coca Cola spent 19% of its last ten years total earnings for capital expenditure.  Moody spent 5% of its total earnings for the last ten years for capital expenditure.

GM used 444% more for capital expenditure than it earned over the last ten years.  Goodyear (tire maker) used 950% more for capital expenditure than it earned over the last ten years.

For GM and Goodyear, where did all that extra money come from?

It came from bank loans and from selling tons of new debt to the public.

Such actions add more debt to these companies’ balance sheets, which increases the amount of money they spend on interest payments and this is never a good thing.

Both Coke and Moody’s, however, have enough excess income to have stock buyback programs that reduce the number of shares outstanding, while at the same time either reducing long-term debt or keeping it low. 

Both these activities helped to identify the businesses with a durable competitive advantage working in their favour.

When looking at capital expenditures in relation to net earnings, add up a company’s total capital expenditures for a ten year period and compare the figure with the company’s total net earnings for the same ten year period.

The reason we look at a ten year period is that it gives us a really good long term perspective as to what is going on with the business.

Historically, durable competitive advantage companies used a far smaller percentage of their net income for capital expenditures.

If a company is historically using 50% of less of its annual net earnings for capital expenditures, it is a good place to look for a durable competitive advantage.

If it is consistently using less than 25% of its net earnings for capital expenditures, that scenario occurs more than likely because the company has a durable competitive advantage working in its favour.

Stock Buybacks

Companies that have a durable competitive advantage working in their favour make a ton of money.

The companies can sit on this cash, or they can reinvest it in the existing business or find a new business to invest in. 

If they don’t require the cash for the above, they can also either pay it out as dividends to their shareholders or use it to buy back shares.

Shareholders have to pay income tax on the dividends.  This doesn’t make anyone happy.

A neater trick is to use some of the excess money that the company is throwing off to buy back the company’s shares.

This reduces the number of outstanding shares – which increases the remaining shareholders’ interest in the company – and increases the per share earnings of the company, which eventually makes the stock price go up.

If the company buys back its own shares it can increase its per share earnings figure even though actual net earnings don’t increase.

The best part is that there is an increase in the shareholders’ wealth that they don’t have to pay taxes on until they sell their stock.

To find out if a company is buying back its shares, go to the cash flow statement and look under Cash from Investing Activities, under a heading titled “Issuance (Retirement) of Stock, Net”.

This entry nets out the selling and buying of the company’s shares.

If the company is buying back its shares year after year, it is a good bet that it is a durable competitive advantage that is generating all the extra cash that allows it to do so.

One of the indicators of the presence of a durable competitive advantage is a “history” of the company repurchasing or retiring its shares.

The Five Rules for Successful Stock Investing 6

Financial Statements Explained

[...] reading financial statements is the foundation for analyzing companies.

The balance sheet [...] tells you how much a company owns (its assets), how much it owes (its liabilities), and the difference between the two (its equity). Equity represents the value of the money that shareholders have invested in the firm [...].

"Cash and equivalents" usually contains money market funds or anything that can be liquidated quickly and with minimal price risk, whereas "short-term investments" is similar to cash – usually, bonds that have less than a year to maturity and earn a higher rate of return than cash but would take a bit of effort to sell.

[...] accounts receivable are bills that the company hasn't yet collected but for which it expects to receive payment soon.

Comparing the growth rate of accounts receivable with the growth rate of sales is a good way to judge whether a company is doing a good job collecting the money that it's owed by customers.

You'll often see an "allowance for doubtful accounts" just after accounts receivable on the balance sheet. This is the company's estimate of how much money it's owed by deadbeat customers, and which it's consequently unlikely to collect.

There are several types of inventories, including raw materials that have not yet been made into a finished product, partially finished products, and finished products that have not yet been sold. 

Inventories are especially important to watch in manufacturing and retail firms, and their value on the balance sheet should be taken with a grain of salt. Because of the way inventories are accounted for, their liquidation value may very well be a far cry from their value on the balance sheet.

Inventories soak up capital – cash that's been converted into inventory sitting in a warehouse can't be used for anything else. The speed at which a company turns over its inventory can have a huge impact on profitability because the less time cash is tied up in inventory, the more time it's available for use elsewhere. You can calculate a metric called inventory turnover by dividing a company's cost of goods sold by its inventory level.

Noncurrent assets are assets that are not expected to be converted into cash or used up within the reporting period. The big parts of this section are property, plant, and equipment (PP&E); investments; and intangible assets.

The most common form of intangible assets is goodwill, which arises when one company acquires another. Goodwill is the difference between the price the acquiring company pays and tangible value – or equity – of the target company.

[...] the value of goodwill that shows up on the balance sheet is very often far more than the asset is actually worth.

Accounts payable: These are bills the company owes to somebody else and are due to be paid within a year.

Noncurrent liabilities are the flip side of noncurrent assets. They represent money the company owes one year or more in the future.

Retained earnings is a cumulative account; therefore, each year that the company makes a profit and doesn't pay it all out as dividends, retained earnings increase. Likewise, if a company has lost money over time, retained earnings can turn negative and is often renamed "accumulated deficit" on the balance sheet. Think of this account as a company's long-term track record at generating profits.

Be sure to check the "revenue recognition policies" buried in the financial statements so you know what you're looking at – companies can record revenue at different times depending on the business that they're in.

Cost of sales, also known as cost of goods sold, represents the expenses most directly involved in creating revenue, such as labor costs, raw materials (for manufacturers), or the wholesale price of goods (for retailers).

Gross profit is simply revenue minus cost of sales. Once you have gross profit, you can calculate a gross margin, which is gross profit as a percentage of revenue. Essentially, this tells you how much a company is able to mark up its goods.

[...] the more differentiated a company's products are, the more it can mark up its good over what it costs to manufacture them.

Selling, General, and Administrative Expenses (SG&A), also known as operating expenses, includes items such as marketing, administrative salaries, and, sometimes, research and development. (Research and development is usually broken out as a separate line item, as is marketing for firms that spend large amounts on advertising.) You'll often see a relationship between SG&A and gross margin – firms that are able to charge more for their goods have to spend more on salespeople and marketing. You can get a feel for how efficient a firm is by looking at SG&A as a percentage of revenues – a lower percentage of operating expenses relative to sales generally means a tighter, more cost-effective firm.

Depreciation and Amortization: When a company buys an asset intended to last a long time, such as a new building or a piece of machinery, it charges off a portion of the cost of that asset on its income statement over a series of years. This number is occasionally broken out separately on the income statement, but it's usually rolled into operating expenses. It's always included in the cash flow statement, though, so you can look there to see how much a company's net income was affected by noncash charges such as depreciation.

Nonrecurring Charges/Gains is the catch-all area where companies put all the one-time charges or gains that aren't part of their regular, ongoing operations, such as the cost of closing a factory or the gain from selling a division. Ideally, you'd want to see this area of the income statement blank most of the time.

Operating Income is equal to revenues minus cost of sales and all operating expenses. Theoretically, it represents the profit the company made from its actual operations, as opposed to interest income, one-time gains, and so forth. In practice, companies often include nonrecurring expenses (such as write-offs) in figuring operating income, and you have to add back one-time charges (or subtract one-time gains) yourself.

Interest Income/Expense represents interest the company has paid on bonds it has issued or received on bonds or cash that it owns.

Net Income represents (at least theoretically) the company's profit after all expenses have been paid. [...] Although net income is the number you'll most often see companies tout in their press releases, don't forget that it can be wildly distorted by one-time charges and/or investment income.

Number of Shares (Basic and Diluted) represents the number of shares used in calculating earnings per share; it represents the average number of shares outstanding during the reporting period. Basic shares include only actual shares of stock, and you should pretty much ignore it – the fact that it's still recorded in financial statements is more of a historical legacy than anything else. Diluted shares, however, include securities that could potentially be converted into shares of stock, such as stock options and convertible bonds. Given the amount of egregious granting of stock options that has occurred over the past several years, it's the diluted number that you'll want to look at, because you want to know the degree to which your stake in the firm could potentially be shrunk (or diluted) if all those option-holders convert their options into shares.

The cash flow statement strips away all the abstract, noncash items such as depreciation that you see on the income statement and tells you how much actual cash the company has generated. [...] The cash flow statement is divided into three parts: cash flows from operating activities, from investing activities, and from financing activities.

If you can't understand how a dollar flows from a company's customers back through to shareholders, something's amiss. Either the company's business model is too confusing or you need to do more digging before committing any of your money.

When you're evaluating a company's liabilities, remember that debt is a fixed cost. A big chunk of long-term debt can be risky for a company because the interest has to be paid no matter how business is doing.

http://books.danielhofstetter.com/the-five-rules-for-successful-stock-investing/

Warren Buffett's Interpretation of Financial Statements and Analysis

Warren Buffett's Interpretation of Financial Statements and Analysis




Warren Buffett's Interpretation of the Income Statement and Analysis



Warren Buffett's Interpretation of a Balance Sheet and Analysis



Warren Buffett's Interpretation of Cash Flows and Analysis

How to use a cash flow statement to identify strong versus risky companies

What is a Cash Flow Statement

This important document is used to help determine how money flows through a business. Prior to 1987, investors could only examine the health of a company from the income statement and balance sheet. Due to stricter regulations, publicly traded companies are now required to also disclose the cash flow statement.

The cash flow statement is broken down into three categories. 

1. Operating Activities: This is probably the most important section of the statement because it shows the money that's flowing into the business from the product or service that the company produces. Positive revenues listed on the cash flow statement from other activities are not sustainable in the long term, so that's why this section is so important. 

2. Investing Activities: A negative number listed in this section would mean that the company is investing money. A positive number in this section would mean that the company sold an asset in order to generate money. Obviously its better to see a negative number show-up under this section because it implies that the company is continuing to invest the revenues that it produces. 

3. Financing Activities: In this section, an investor can identify whether the business is try to raise money or pay off debts. A positive number in this section means the company is incurring debt or dilute the value of their shares. A negative number means the company is paying off debt or increasing the value of their shares (through a share buy back). Generally speaking its good to see a negative number under this section because it means the company is removing their leverage and creating a stronger position for their shareholders.

The Cash flow is a great document to help look at trends and how money flows through a business. Although the balance sheet and income statement are very useful documents for determining the intrinsic value of a stable company, the cash flow statement gives potential investors a glimpse into the current conditions of the company and how they manage their resources.

http://www.buffettsbooks.com/intelligent-investor/cash-flow-statement/what-is-cash-flow-statement.html



How to read the cash flow statement
http://www.buffettsbooks.com/intelligent-investor/cash-flow-statement/how-to-read-cash-flow-statement.html

Financial Statements: Introduction

Table of Contents

1. Financial Statements: Introduction
2. Financial Statements: Who's In Charge?
3. Financial Statements: The System
4. Financial Statements: Cash Flow
5. Financial Statements: Earnings
6. Financial Statements: Revenue
7. Financial Statements: Working Capital
8. Financial Statements: Long-Lived Assets
9. Financial Statements: Long-Term Liabilities
10. Financial Statements: Pension Plans
11. Financial Statements: Conclusion

Financial Statements:

Introduction
By David Harper

Whether you watch analysts on CNBC or read articles in The Wall Street Journal, you'll hear experts insisting on the importance of "doing your homework" before investing in a company. In other words, investors should dig deep into the company's financial statements and analyze everything from the auditor's report to the footnotes. But what does this advice really mean, and how does an investor follow it?

The aim of this tutorial is to answer these questions by providing a succinct yet advanced overview of financial statements analysis. If you already have a grasp of the definition of the balance sheet and the structure of an income statement, this tutorial will give you a deeper understanding of how to analyze these reports and how to identify the "red flags" and "gold nuggets" of a company. In other words, it will teach you the important factors that make or break an investment decision.

If you are new to financial statements, don't despair - you can get the background knowledge you need in the Intro To Fundamental Analysis tutorial. Read more: http://www.investopedia.com/university/financialstatements/#ixzz279MZnu00

The Essentials Of Corporate Cash Flow (3)

Digging Deeper into Cash Flow
All companies provide cash flow statements as part of their financial statements, but cash flow (net change in cash and equivalents) can also be calculated as net income plus depreciation and other non-cash items.

Generally, a company's principal industry of operation determine what is considered proper cash flow levels; comparing a company's cash flow against its industry peers is a good way to gauge the health of its cash flow situation. A company not generating the same amount of cash as competitors is bound to lose out when times get rough.

Even a company that is shown to be profitable according to accounting standards can go under if there isn't enough cash on hand to pay bills. Comparing amount of cash generated to outstanding debt, known as the operating cash flow ratio, illustrates the company's ability to service its loans and interest payments. If a slight drop in a company's quarterly cash flow would jeopardize its loan payments, that company carries more risk than a company with stronger cash flow levels.


Unlike reported earnings, cash flow allows little room for manipulation. Every company filing reports with the Securities and Exchange Commission (SEC) is required to include a cash flow statement with its quarterly and annual reports. Unless tainted by outright fraud, this statement tells the whole story of cash flow: either the company has cash or it doesn't.


What Cash Flow Doesn't Tell Us
Cash is one of the major lubricants of business activity, but there are certain things that cash flow doesn't shed light on. For example, as we explained above, it doesn't tell us the profit earned or lost during a particular period: profitability is composed also of things that are not cash based. This is true even for numbers on the cash flow statement like "cash increase from sales minus expenses", which may sound like they are indication of profit but are not.

As it doesn't tell the whole profitability story, cash flow doesn't do a very good job of indicating the overall financial well-being of the company. Sure, the statement of cash flow indicates what the company is doing with its cash and where cash is being generated, but these do not reflect the company's entire financial condition. The cash flow statement does not account for liabilities and assets, which are recorded on the balance sheet. Furthermore accounts receivable and accounts payable, each of which can be very large for a company, are also not reflected in the cash flow statement.

In other words, the cash flow statement is a compressed version of the company's checkbook that includes a few other items that affect cash, like the financing section, which shows how much the company spent or collected from the repurchase or sale of stock, the amount of issuance or retirement of debt and the amount the company paid out in dividends.

The Bottom Line
Like so much in the world of finance, the cash flow statement is not straightforward. You must understand the extent to which a company relies on the capital markets and the extent to which it relies on the cash it has itself generated. No matter how profitable a company may be, if it doesn't have the cash to pay its bills, it will be in serious trouble.

At the same time, while investing in a company that shows positive cash flow is desirable, there are also opportunities in companies that aren't yet cash-flow positive. The cash flow statement is simply a piece of the puzzle. So, analyzing it together with the other statements can give you a more overall look at a company' financial health. Remain diligent in your analysis of a company's cash flow statement and you will be well on your way to removing the risk of one of your stocks falling victim to a cash flow crunch.

by Investopedia Staff
Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including thousands of original and objective articles and tutorials on a wide variety of financial topics.


Read more: http://www.investopedia.com/articles/01/110701.asp#ixzz1hW0PDzMV

The Essentials Of Corporate Cash Flow (2)

What Is the Cash Flow Statement?
There are three important parts of a company's financial statements: the balance sheet, the income statement and the cash flow statement. The balance sheet gives a one-time snapshot of a company's assets and liabilities (see Reading the Balance Sheet). And the income statement indicates the business's profitability during a certain period (see Understanding The Income Statement).

The cash flow statement differs from these other financial statements because it acts as a kind of corporate checkbook that reconciles the other two statements. Simply put, the cash flow statement records the company's cash transactions (the inflows and outflows) during the given period. It shows whether all those lovely revenues booked on the income statement have actually been collected. At the same time, however, remember that the cash flow does not necessarily show all the company's expenses: not all expenses the company accrues have to be paid right away. So even though the company may have incurred liabilities it must eventually pay, expenses are not recorded as a cash outflow until they are paid (see the section "What Cash Flow Doesn't Tell Us" below).

The following is a list of the various areas of the cash flow statement and what they mean:

Cash flow from operating activities - This section measures the cash used or provided by a company's normal operations. It shows the company's ability to generate consistently positive cash flow from operations. Think of "normal operations" as the core business of the company. For example, Microsoft's normal operating activity is selling software.
Cash flows from investing activities - This area lists all the cash used or provided by the purchase and sale of income-producing assets. If Microsoft, again our example, bought or sold companies for a profit or loss, the resulting figures would be included in this section of the cash flow statement.
Cash flows from financing activities - This section measures the flow of cash between a firm and its owners and creditors. Negative numbers can mean the company is servicing debt but can also mean the company is making dividend payments and stock repurchases, which investors might be glad to see.

When you look at a cash flow statement, the first thing you should look at is the bottom line item that says something like "net increase/decrease in cash and cash equivalents", since this line reports the overall change in the company's cash and its equivalents (the assets that can be immediately converted into cash) over the last period. If you check under current assets on the balance sheet, you will find cash and cash equivalents (CCE or CC&E). If you take the difference between the current CCE and last year's or last quarter's, you'll get this same number found at the bottom of the statement of cash flows.

In the sample Microsoft annual cash flow statement (from June 2004) shown below, we can see that the company ended up with about $9.5 billion more cash at the end of its 2003/04 fiscal year than it had at the beginning of that fiscal year (see "Net Change in Cash and Equivalents"). Digging a little deeper, we see that the company had a negative cash outflow of $2.7 billion from investment activities during the year (see "Net Cash from Investing Activities"); this is likely from the purchase of long-term investments, which have the potential to generate a profit in the future.Generally, a negative cash flow from investing activities are difficult to judge as either good or bad - these cash outflows are investments in future operations of the company (or another company); the outcome plays out over the long term.

The "Net Cash from Operating Activities" reveals that Microsoft generated $14.6 billion in positive cash flow from its usual business operations - a good sign. Notice the company has had similar levels of positive operating cash flow for several years. If this number were to increase or decrease significantly in the upcoming year, it would be a signal of some underlying change in the company's ability to generate cash.


Read more: http://www.investopedia.com/articles/01/110701.asp#ixzz1hVxZy4dt

The Essentials Of Corporate Cash Flow (1)

The Essentials Of Corporate Cash Flow

Posted: Mar 14, 2011
Investopedia Staff


ARTICLE HIGHLIGHTS
To be positive, the company's long-term cash inflows need to exceed its outflows.
Just because a company is bringing in cash does not mean it is making a profit.


If a company reports earnings of $1 billion, does this mean it has this amount of cash in the bank? Not necessarily. Financial statements are based on accrual accounting, which takes into account non-cash items. It does this in an effort to best reflect the financial health of a company. However, accrual accounting may create accounting noise, which sometimes needs to be tuned out so that it's clear how much actual cash a company is generating. The statement of cash flow provides this information, and here we look at what cash flow is and how to read the cash flow statement.

What Is Cash Flow?
Business is all about trade, the exchange of value between two or more parties, and cash is the asset needed for participation in the economic system. For this reason - while some industries are more cash intensive than others - no business can survive in the long run without generating positive cash flow per share for its shareholders. To have a positive cash flow, the company's long-term cash inflows need to exceed its long-term cash outflows. (For more, see What Is Money?)

An outflow of cash occurs when a company transfers funds to another party (either physically or electronically). Such a transfer could be made to pay for employees, suppliers and creditors, or to purchase long-term assets and investments, or even pay for legal expenses and lawsuit settlements. It is important to note that legal transfers of value through debt - a purchase made on credit - is not recorded as a cash outflow until the money actually leaves the company's hands.

A cash inflow is of course the exact opposite; it is any transfer of money that comes into the company's possession. Typically, the majority of a company's cash inflows are from customers, lenders (such as banks or bondholders) and investors who purchase company equity from the company. Occasionally cash flows come from sources like legal settlements or the sale of company real estate or equipment.


Cash Flow vs Income
It is important to note the distinction between being profitable and having positive cash flow transactions: just because a company is bringing in cash does not mean it is making a profit (and vice versa).

For example, say a manufacturing company is experiencing low product demand and therefore decides to sell off half its factory equipment at liquidation prices. It will receive cash from the buyer for the used equipment, but the manufacturing company is definitely losing money on the sale: it would prefer to use the equipment to manufacture products and earn an operating profit. But since it cannot, the next best option is to sell off the equipment at prices much lower than the company paid for it. In the year that it sold the equipment, the company would end up with a strong positive cash flow, but its current and future earnings potential would be fairly bleak. Because cash flow can be positive while profitability is negative, investors should analyze income statements as well as cash flow statements, not just one or the other.

Read more: http://www.investopedia.com/articles/01/110701.asp#ixzz1hVwE5gVi

The difference between Earnings and Cash - Analyze Cash Flow The Easy Way

Summary

Once you understand the importance of how cash flow is generated and reported, you can use these simple indicators to conduct an analysis on your own portfolio. 

The point is to stay away from "looking only at a firm's income statement and not the cash flow statement." 

This approach will allow you to discover how a company is managing to pay its obligations and make money for its investors.

Difference Between Earnings and Cash

At least as important as a company's profitability is its liquidity - whether or not it's taking in enough money to meet its obligations. 

Companies, after all, go bankrupt because they cannot pay their bills, not because they are unprofitable. 

The Statement of Cash Flows


Cash flow statements have three distinct sections, each of which relates to a particular component - operations, investing and financing - of a company's business activities.

1.  Cash Flow from Operations: 

-  This is the key source of a company's cash generation. 

-  It is the cash that the company produces internally as opposed to funds coming from outside investing and financing activities. 

-  In this section of the cash flow statement, net income (income statement) is adjusted for non-cash charges and the increases and decreases to working capital items - operating assets and liabilities in the balance sheet's current position.

2.  Cash Flow from Investing: 

-  For the most part, investing transactions generate cash outflows, such as capital expenditures for plant, property and equipment, business acquisitions and the purchase of investment securities. 

-  Inflows come from the sale of assets, businesses and investment securities.

-  For investors, the most important item in this category is capital expenditures. 

-  It's generally assumed that this use of cash is a prime necessity for ensuring the proper maintenance of, and additions to, a company's physical assets to support its efficient operation and competitiveness.

3.  Cash Flow from Financing: 

-  Debt and equity transactions dominate this category. 

-  Companies continuously borrow and repay debt. 

-  The issuance of stock is much less frequent. 

-  Here again, for investors, particularly income investors, the most important item is cash dividends paid. It's cash, not profits, that is used to pay dividends to shareholders.

A Simplified Approach to Cash Flow Analysis


-  A company's cash flow can be defined as the number that appears in the cash flow statement as net cash provided by operating activities, or "net operating cash flow".

-  Many financial professionals consider a company's cash flow to be the sum of its net income and depreciation (a non-cash charge in the income statement). While often coming close to net operating cash flow, this professional's short-cut can be way off the mark and investors should stick with the net operating cash flow number.

Indicators to measure investment quality of company's cash flow 


The following indicators provide a starting point for an investor to measure the investment quality of a company's cash flow:

1.  Operating Cash Flow / Net Sales: 

-  This ratio, which is expressed as a percentage of a company's net operating cash flow to its net sales, or revenue (from the income statement), tells us how many dollars of cash we get for every dollar of sales.
-  There is no exact percentage to look for but obviously, the higher the percentage the better. 

-  It should also be noted that industry and company ratios will vary widely. Investors should track this indicator's performance historically to detect significant variances from the company's average cash flow/sales relationship along with how the company's ratio compares to its peers. 

-  Also, keep an eye on how cash flow increases as sales increase; it is important that they move at a similar rate over time.

2.  (a)  Free Cash Flow: 

-  Free cash flow is often defined as net operating cash flow minus capital expenditures, which, as mentioned previously, are considered obligatory. 

- A steady, consistent generation of free cash flow is a highly favorable investment quality – so make sure to look for a company that shows steady and growing free cash flow numbers.


FCF = 
Net Operating Cash Flow - Capital Expenditures

2 (b).  Comprehensive Free Cash Flow:
-  For the sake of conservatism, you can go one step further by expanding what is included in the free cash flow number. 

-  For example, in addition to capital expenditures, you could also include dividends for the amount to be subtracted from net operating cash flow to get to get a more comprehensive sense of free cash flow. 

Comprehensive FCF 
= Net Operating Cash Flow - Capital expenditure - dividends.

-  This could then be compared to sales as was shown above.


FCF / Net Sales
Comprehensive FCF / Net Sales


-  As a practical matter, if a company has a history of dividend payments, it cannot easily suspend or eliminate them without causing shareholders some real pain. 

-  Even dividend payout reductions, while less injurious, are problematic for many shareholders. 

-  In general, the market considers dividend payments to be in the same category as capital expenditures - as necessary cash outlays.
-  But the important thing here is looking for stable levels. This shows not only the company's ability to generate cash flow but it also signals that the company should be able to continue funding its operations. 

3..  Comprehensive Free Cash Flow Coverage: 

-You can calculate a comprehensive free cash flow ratio by dividing the comprehensive free cash flow by net operating cash flow to get a percentage ratio - the higher the percentage the better.


Comprehensive FCF Coverage 
=  Comprehensive FCF / Net operating cash flow


Importance of free cash flow.


Free cash flow is an important evaluative indicator for investors. 

- It captures all the positive qualities of internally produced cash from a company's operations and subjects it to a critical use of cash - capital expenditures. 

-  If a company's cash generation passes this test in a positive way, it is in a strong position to avoid excessive borrowing, expand its business, pay dividends and to weather hard times.

-  The term "cash cow," which is applied to companies with ample free cash flow, is not a very elegant term, but it is certainly one of the more appealing investment qualities you can apply to a company with this characteristic. 



Read more:http://www.investopedia.com/articles/stocks/07/easycashflow.asp#ixzz1hPqfkDZZ

Analyze Cash Flow The Easy Way

Analyze Cash Flow The Easy Way

Posted: Jan 17, 2007
Richard Loth


If you believe in the old adage, "it takes money to make money," then you can grasp the essence of cash flow and what it means to a company. The statement of cash flows reveals how a company spends its money (cash outflows) and where the money comes from (cash inflows). (To read more about cash flow statements, see What Is A Cash Flow Statement?, Operating Cash Flow: Better Than Net Income? and The Essentials Of Cash Flow.)


We know that a company's profitability, as shown by its net income, is an important investment evaluator. It would be nice to be able to think of this net income figure as a quick and easy way to judge a company's overall performance. However, although accrual accounting provides a basis for matching revenues and expenses, this system does not actually reflect the amount the company has received from the profits illustrated in this system. This can be a vital distinction. In this article, we'll explain what the cash flow statement can tell you and show you where to look to find this information.

Difference Between Earnings and Cash
In an August 1995 article in Individual Investor, Jonathan Moreland provides a very succinct assessment of the difference between earnings and cash. He says "at least as important as a company's profitability is its liquidity - whether or not it's taking in enough money to meet its obligations. Companies, after all, go bankrupt because they cannot pay their bills, not because they are unprofitable. Now, that's an obvious point. Even so, many investors routinely ignore it. How? By looking only at a firm's income statement and not the cash flow statement."

The Statement of Cash Flows
Cash flow statements have three distinct sections, each of which relates to a particular component - operations, investing and financing - of a company's business activities. For the less-experienced investor, making sense of a statement of cash flows is made easier by the use of literally-descriptive account captions and the standardization of the terminology and presentation formats used by all companies:

Cash Flow from Operations: This is the key source of a company's cash generation. It is the cash that the company produces internally as opposed to funds coming from outside investing and financing activities. In this section of the cash flow statement, net income (income statement) is adjusted for non-cash charges and the increases and decreases to working capital items - operating assets and liabilities in the balance sheet's current position.

Cash Flow from Investing: For the most part, investing transactions generate cash outflows, such as capital expenditures for plant, property and equipment, business acquisitions and the purchase of investment securities. Inflows come from the sale of assets, businesses and investment securities. For investors, the most important item in this category is capital expenditures (more on this later). It's generally assumed that this use of cash is a prime necessity for ensuring the proper maintenance of, and additions to, a company's physical assets to support its efficient operation and competitiveness.

Cash Flow from Financing: Debt and equity transactions dominate this category. Companies continuously borrow and repay debt. The issuance of stock is much less frequent. Here again, for investors, particularly income investors, the most important item is cash dividends paid. It's cash, not profits, that is used to pay dividends to shareholders.

A Simplified Approach to Cash Flow Analysis
A company's cash flow can be defined as the number that appears in the cash flow statement as net cash provided by operating activities, or "net operating cash flow", or some version of this caption. However, there is no universally accepted definition. For instance, many financial professionals consider a company's cash flow to be the sum of its net income and depreciation (a non-cash charge in the income statement). While often coming close to net operating cash flow, this professional's short-cut can be way off the mark and investors should stick with the net operating cash flow number.

While cash flow analysis can include several ratios, the following indicators provide a starting point for an investor to measure the investment quality of a company's cash flow:

Operating Cash Flow / Net Sales: This ratio, which is expressed as a percentage of a company's net operating cash flow to its net sales, or revenue (from the income statement), tells us how many dollars of cash we get for every dollar of sales.

There is no exact percentage to look for but obviously, the higher the percentage the better. It should also be noted that industry and company ratios will vary widely. Investors should track this indicator's performance historically to detect significant variances from the company's average cash flow/sales relationship along with how the company's ratio compares to its peers. Also, keep an eye on how cash flow increases as sales increase; it is important that they move at a similar rate over time.

History of Free Cash Flow: Free cash flow is often defined as net operating cash flow minus capital expenditures, which, as mentioned previously, are considered obligatory. A steady, consistent generation of free cash flow is a highly favorable investment quality – so make sure to look for a company that shows steady and growing free cash flow numbers.

For the sake of conservatism, you can go one step further by expanding what is included in the free cash flow number. For example, in addition to capital expenditures, you could also include dividends for the amount to be subtracted from net operating cash flow to get to get a more comprehensive sense of free cash flow. This could then be compared to sales as was shown above.

As a practical matter, if a company has a history of dividend payments, it cannot easily suspend or eliminate them without causing shareholders some real pain. Even dividend payout reductions, while less injurious, are problematic for many shareholders. In general, the market considers dividend payments to be in the same category as capital expenditures - as necessary cash outlays.

But the important thing here is looking for stable levels. This shows not only the company's ability to generate cash flow but it also signals that the company should be able to continue funding its operations. (To read more about cash flow, see Free Cash Flow: Free, But Not Always Easy, Taking Stock Of Discounted Cash Flow and Discounted Cash Flow Analysis.)

Comprehensive Free Cash Flow Coverage: You can calculate a comprehensive free cash flow ratio by dividing the comprehensive free cash flow by net operating cash flow to get a percentage ratio - the higher the percentage the better.

Free cash flow is an important evaluative indicator for investors. It captures all the positive qualities of internally produced cash from a company's operations and subjects it to a critical use of cash - capital expenditures. If a company's cash generation passes this test in a positive way, it is in a strong position to avoid excessive borrowing, expand its business, pay dividends and to weather hard times.

The term "cash cow," which is applied to companies with ample free cash flow, is not a very elegant term, but it is certainly one of the more appealing investment qualities you can apply to a company with this characteristic. (Read more about cash cows in Spotting Cash Cows.)

Conclusion
Once you understand the importance of how cash flow is generated and reported, you can use these simple indicators to conduct an analysis on your own portfolio. The point, like Moreland said above, is to stay away from "looking only at a firm's income statement and not the cash flow statement." This approach will allow you to discover how a company is managing to pay its obligations and make money for its investors.

Read more: http://www.investopedia.com/articles/stocks/07/easycashflow.asp#ixzz1hPqfkDZZ