Wednesday, April 10, 2013

Cash Flow Statements

The cash flow statement is one of the easier ones to read. It is also the statement that counts the most because cash flows are important and because it is hard to fool around with the cash flow statement. Cash Flow is not like earnings where earnings (EPS) are rather a fake number. The value of the EPS is that it allows people to compare different stocks on the same basis.

The value of the Cash Flow Statements is it is not a vulnerable to manipulation as other statements can be. (Also please note that accounting is more art than science.) When determining cash flow per share, analysts often will exclude changes in working capital in calculating Cash Flow from operations, no matter what the company does in their annual reports.

If we do not exclude working capital form the Cash Flow from operations, the cash flow we are looking at may not properly reflect how a company is doing. Note that changes in working capital are changes in current assets and current liabilities.

You can generally find financial statements at a company's site. (I always include a company's website when I review a stock.) I need information from the cash flow statements for my spreadsheets in order for me to analyze a stock. Also Google Financial and Globe and Mail Investing both analyze and give a breakdown of financial statements for many companies.

For a good explanation of the cash flow statement items look at information on Investors Friend. There is also an Investopedia article that talks about why Cash Flow is better than Net Income as a metric of a company's financial health .

This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. See my site for an index to these blog entries and for stocks followed. Follow me on Twitter.


  1. I agree with using the Cash Flow as the starting point.

    Free Cash Flow is the holy grail for me - if a company has no Free Cash Flow and consistent Free Cash Flow, then I usually do not bother.

    This is just a rule of thumb, sometimes there are exceptions. This rule helps keep you out of trouble, or fancy accounting.

    1. It can be dangerous to reducing companies to one metric like FCF. Everyone seems to be talking about it. Then you get companies that will produce what is required (ie. FCF). Then you get perverse unexpected consequences. I truly find humans very marvelous being.

  2. There is no suggestion to reduce one's analysis to one metric. It is a starting point only - a great starting point.

    If a company has lots of FCF but tons of debt then that would raise some questions for me. If a company had lots of FCF and lots of cash in the bank, that too would raise questions (AAPL comes to mind). Earnings growth, ROA and ROE are other metrics that must be considered but they are almost meaningless if FCF is consistently low or close to zero.

    The metric that I use to start my analysis is P/FCF. If the Price/FCF is above 20 then I am very cautious. If it is below then I continue with my analysis.

    Cash is the only thing that an investor wants - if the company is not producing cash then I just move on.

    Yes, it is possible to find a company producing no FCF but will do so in the future, I think Magna in the 80's was one such example. I believe that picking such "diamonds in the rough" is difficult and the probability of success is too low for me - it is above my skill level.

    I cannot think of a "perverse unexpected consequences" of having a healthy FCF.

    1. I cannot think of a "perverse unexpected consequences" of having a healthy FCF.

      Make a CEO’s salary dependent on producing a health FCF because that is what analysts are looking for.