Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ====== Cash Flows ====== Cash Flows refer to the net amount of cash and cash-equivalents being transferred into and out of a company. Think of it as the financial pulse of a business, measuring the real money moving through its veins. While accounting //profits// can sometimes feel like a fantasy novel—full of assumptions and non-cash entries—cash flow is the hard, cold reality. A company can report a massive profit but go bankrupt if it doesn't have enough cash to pay its bills, employees, and suppliers. For a [[value investing|value investor]], understanding a company's cash flow is non-negotiable. It cuts through the accounting fog to reveal the true economic health and cash-generating power of an enterprise. A business that consistently generates more cash than it consumes is a business that is creating real, tangible value for its owners. ===== Why Cash is King ===== In the world of accounting, most companies use the [[accrual accounting]] method. This means they record revenues when they are //earned// and expenses when they are //incurred//, regardless of when the actual cash changes hands. For example, a company might sell a product on credit, recording the sale as revenue immediately. But if the customer never pays, that "revenue" was an illusion. This is where cash flow analysis shines. It ignores non-cash items like [[depreciation]] (an accounting charge to spread the cost of an asset over its life) and changes in [[accounts receivable]] (money owed by customers). Instead, it follows the actual cash. A famous quote, often attributed to former General Electric CEO Jack Welch's CFO, Dennis Dammerman, sums it up perfectly: **"Revenue is vanity, profit is sanity, but cash is reality."** By focusing on cash flows, investors can better assess a company's ability to fund its operations, invest for growth, and return capital to shareholders without relying on external financing. ===== The Three Flavors of Cash Flow ===== A company's financial story is told through its [[Statement of Cash Flows]], which neatly organizes these movements into three main categories. Understanding each part helps you see exactly where the money is coming from and where it's going. ==== Cash Flow from Operations (CFO) ==== This is the big one. [[Cash Flow from Operations (CFO)]] represents the cash generated from a company's core, day-to-day business activities. It’s the cash that comes in from selling goods and services, minus the cash paid out for expenses like raw materials, salaries, and rent. A consistently strong and growing CFO is the hallmark of a healthy, successful business. It shows that the company's fundamental business model is profitable and self-sustaining. If a company can't generate positive cash flow from its main operations over the long term, it’s a major red flag, suggesting it may be burning through cash just to stay afloat. ==== Cash Flow from Investing (CFI) ==== [[Cash Flow from Investing (CFI)]] tracks the cash used for, or generated from, a company's investments. This includes: * The purchase or sale of long-term assets, such as [[Property, Plant, and Equipment (PP&E)]]. * The purchase or sale of other companies or investment securities. A negative CFI is often a good sign for a growing company, as it means the business is investing in its future by buying new machinery or facilities. Conversely, a consistently positive CFI might mean the company is selling off assets to raise cash, which could be a sign of distress. Context is everything here: Is the company selling a non-core division to focus on its strengths, or is it selling the family silver to pay the bills? ==== Cash Flow from Financing (CFF) ==== [[Cash Flow from Financing (CFF)]] details the flow of cash between a company and its owners (shareholders) and creditors (lenders). Activities in this section include: * Issuing or buying back company stock. * Taking on new debt or paying off existing loans. * Paying [[dividends]] to shareholders. A healthy, mature company might have a negative CFF because it is using its cash to pay down debt and reward shareholders with dividends and buybacks. A young, growing company might have a positive CFF because it is raising capital by issuing new stock or taking on debt to fund its expansion. ===== Putting It All Together for the Value Investor ===== For a value investor, the goal is to find wonderful businesses at fair prices. Analyzing cash flows is central to determining both "wonderful" and "fair." ==== Free Cash Flow (FCF) - The Holy Grail ==== The most prized metric derived from the cash flow statement is [[Free Cash Flow (FCF)]]. This represents the cash a company generates after accounting for the cash outflows to support operations and maintain its capital assets. In simple terms, it's the surplus cash that a company is free to use to benefit its shareholders. The basic formula is: **Free Cash Flow (FCF) = Cash Flow from Operations - [[Capital Expenditures (CapEx)]]** This FCF is the money available to pay down debt, distribute as dividends, buy back shares, or make acquisitions. A company that consistently gushes FCF is like a golden goose for investors. It's also the foundation for many [[valuation]] methods, most notably the [[Discounted Cash Flow (DCF)]] model, which attempts to estimate a company's value today based on its projected future free cash flows. ==== Red Flags and Green Lights ==== When analyzing a company's cash flows, keep an eye out for these patterns: * **Green Light:** Consistently positive and growing CFO. This is the engine of value creation. * **Green Light:** FCF that is consistently positive and growing over time. * **Red Flag:** Negative CFO for multiple years. The core business is losing money. * **Red Flag:** The company consistently relies on issuing debt (positive CFF) or selling assets (positive CFI) to fund its operational shortfall (negative CFO). This is an unsustainable model. * **Red Flag:** High levels of [[stock-based compensation]]. While it's a non-cash expense that gets added back to CFO, it dilutes existing shareholders' ownership and should be considered a real economic cost.