Cashflow can be a good number to study before you invest in a company. Cashflow can be helpful to determine a company’s ability to settle debts, reinvest in their company, return money to shareholders, pay expenses, and to have a buffer for anything that may happen to the business.
Cashflow is not the profit of a business and it is also often confused with earnings. While earnings are being reported by a company, cashflow shows a lot more about a company. Cashflow would show you how a company is managing its funds whether they are spending more money than they should or if they are managing their funds well.
What is Cashflow
Cashflow is basically a net amount of cash that a business/company has. Cashflow is affected by the activities of a business that includes money in and out of their bank account.
One very simple example would be revenue when a business made a sale and that is money in. An example of money out would be paying for utility bills.
By knowing the cashflow of a company, you would be able to visualize where the money is coming from or what is making them lose money. A company with good cashflow would usually mean that they have good cash management and the business might be growing well.
How is Cashflow Calculated?
Cashflow can be calculated by adjusting the net income to either add or subtract from revenue, expenses, and credit transactions (Only those who appear on both balance sheets and income statements) which causes transactions to take place from one period to another.
I will be talking about cash from operating activities, cash from investing activities, and cash from financing activities. All these numbers will be useful for you to know about the cashflow of a company.
Cash from Operating Activities
This is possibly the most important out of the 3 as this would tell you about the amount of money a company is earning from its operations.
You can calculate this number by using the amount received for sales to deduct away the cost of the products (can be the supplier), salaries for employees, interest paid on debt, and taxes paid to the government.
Essentially, this is calculating the operating profit of a company. If the operating profit is increasing over a period of time then it means that the company is likely to be growing in size. Whereas a company with decreasing cash from operating activities will indicate that the company is shrinking and the operations are losing money which may result in the business closing down.
Cash from Investing activities
This amount is derived from any purchase or sale of long-term assets such as property or equipment. It is basically any money spent in order to grow the business. Acquiring another company can also be part of this as the intention is to grow your business by buying another company that would help to profit your business.
One simple example would be Grab acquiring Uber in South East Asia to grow its business and dominate the transportation business.
Cashflow in investing is usually negative as it includes a business putting in money to grow its business or putting money to maintain its business.
It can also be positive if a business is receiving cash from its investments or when they sell their assets and get money in return.
Cash from Financial Activities
In this section, the money you get from issuing out shares or bonds will be added here and any money that you take from loans will be added here.
You will deduct away the dividend payments, share paybacks, and your debt repayments.
Positive cash from financial activities means that the company is raising funds to grow its operations.
Negative cash from financial activities means that the business is either issuing share paybacks, dividend payments, or to its creditors which will lower the debt amount.
Net change in cash
When you put the 3 numbers that I explained above, you will be able to get the Net Change in Cash. This amount would tell you if the cash balance of a company increases or decreases over an accounting period. And of course, you would want your cash balance to go up.
Free Cash Flow
Free Cash Flow is very important especially for investors as it can be used to tell how much a company has after deducting all their expenses or obligations.
Free Cash Flow = Cash from Operating Activities – Capital Expenditures
From here, if a company has a good amount of Free Cash Flow, it means that they have a good amount of cash for them to repay their debts, buy back their shares, reinvest to grow their business, and even pursue acquisitions.
Generally, companies who have positive free cash flow are able to self-fund for their growth without having to take on more loans. While companies with negative free cash flow usually are spending more than what they are earning and this can lead to the business lending more money to maintain its business.
Why is it important?
Cashflow will provide you a clearer view as to how the business is doing and this would give you the quality of the business’s earnings. This would then help you to analyze better if a company is doing well and it may help you to decide if a company is a good investment.
