DIGESTING FINANCIAL STATEMENTS: CASH FLOW
Companies generate money from borrowers and/or borrow money from creditors. Next, firms purchase assets and/or finance projects and programs. Then, assets and inventory fuel operations in order to earn money. Lastly, entities pay costs and taxes before returning a portion of earnings to investors and/or lenders.
That is how money works in a business.
Adding financing cash flows, cash flow from investment, and operating cash flow is the easiest way of determining a company’s net cash flow. But the gauge is not broadly used due to the inclusion of financing cash flows, which can influence cash flows positively or negatively. Not to mention the management tends to manipulate the cash flow.
Here are other barometers to measure a cash flow.
Cash flow to company (lenders and shareholders) utilizes free cash flow to the firm (FCFF). It is computed by adding the cash flow from operations (CFO) and after-tax interest, and deducting it from CFI.
Cash flow to operations measures CFO, taking into account the CFO or modified CFO.
Cash flow to shareholders gauge free cash flow to equity, calculated by deducting CFO from CFI.
Take note: cash flow from investment projects the level of net capital expenditures needed to maintain and expand the business. It seeks to subtract costs to finance continuous growth.
Taxes are not accounted at this juncture. Cash flow from operations already entails taxes paid. Normally, majority of analysts and investors prefer after-tax cash flow since tax bills may differ in a year. For valuation purposes, adjusted economic value added or cash flow from operations consider actual taxes paid to come up with more precise tax levels.
It pays to look into cash flow from operations due to the following reasons: 1) to find out cash outflows identified under cash flow from investments which should be recategorized to cash flow from operations; 2) look for temporary CFO channels; 3) pinpoint one-time CFO blips; and 4) take gains out from tax benefits.
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