FFB-Post 19
When analyzing a company, the cash flow statement is a vital tool. It shows the amount of cash flowing in and out of a business over a year, providing a clear picture of the company’s financial health.
Two Key Areas to Focus On:
- Net Cash from Operating Activities: This section highlights the cash generated from the company’s core business operations. Consistent positive cash flow from operations is a good sign that the business is effectively converting its day-to-day activities into actual cash. It’s like checking if the engine of your car is running smoothly—without this, the business can’t sustain itself for long.
- Free Cash Flow (FCF): This is the amount of cash left over after the company has covered all necessary expenses, particularly capital expenditures, which are required to maintain its assets. Free cash flow represents the cash available to shareholders after all the business’s operational needs have been met. In simpler terms, if the business were to stop operations today, FCF is the cash shareholders could claim.
- Quick Formula:
Free Cash Flow = Net Cash from Operating Activities – Capital Expenditures
Why These Matter:
- Net Cash from Operating Activities tells us if the business is generating enough cash from its primary activities. It’s a direct reflection of operational efficiency.
- Free Cash Flow shows the money left for shareholders, indicating the company’s financial flexibility and its ability to invest in growth, pay dividends, or reduce debt.
With these two points, we now have five critical aspects to consider when evaluating a business:
- Is the equity of the business growing over time?
- Does the business have a manageable level of debt?
- Are profits consistently growing?
- Is the company generating a good Return on Equity (ROE)?
- Does the business have strong and consistent cash flow?
These checkpoints will guide you in making informed investment decisions.
In the next post, we’ll dive into the world of valuation—understanding how to determine the true worth of a company. Stay tuned!
For Post 20 – Click Here -> Valuation: Heart of Investing