Cash Flow

I like to make a note here on Cash Flow because it is such an important item to be looked at when someone is evaluating a company, but more often than not, it is typically not highlighted in the press releases when reporting quarterly or annual results.

The cash flow of a business is the total amount of cash actually received in a given period minus the total amount of cash actually paid out in that same period. Positive cash flow is the receipt of more cash than was paid out; negative cash flow results from paying out more cash than receiving.

Cash Flow = Cash Received - Cash Paid

In accrual accounting, which most companies use, income is listed when it is earned, even before it is actually received, and expenses are recorded before the money is actually paid out. Depreciation or amortization, for instance, is an expense that doesn't require the immediate payout of cash. Thus, net income alone, which is the income after all expenses are subtracted from all income in a given time period is not an accurate representation of how much cash a company has, or even how much it is generating.

Cash Flow = Net Income + Depreciation + Other Noncash Expenses

For companies in matured or regulated industries, the main evaluation should really be the stability of their cash flow generation since at the end of the day, when you invest in these companies, what you really are investing is in the cash generating power of these businesses.

Watch out for the company Cash Flow from Operating Activities figure every quarter if  you have significant investment in these companies. If you see major deviation in the trend, you should really find out why.

Additional concept you may encounter is Free Cash Flow (FCF)

Free Cash Flow (FCF) = Cash Flow from Operating Activities - Capex

FCF is a measure of how much value can be extracted from the company without altering the cash generating power of the company. You need not be alarmed if you see in certain quarter where the company may be running into negative FCF because it may need to make major capital expenditure during those times to upgrade the business. But consistent negative FCF over many quarters should be investigated thoroughly. If you consistently track these numbers with those companies you own, you will start to understand their businesses.