The cash flow statement is full of important information, for you we have defined and explored 4 cash flow statement metrics that you can start utilizing in order to pick some winning stocks.
Free Cash Flow
Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. Unlike earnings or net income, free cash flow is a measure of profitability that excludes the non-cash expenses of the income statement and includes spending on equipment and assets as well as changes in working capital from the balance sheet.
Because FCF accounts for changes in working capital, it can provide important insights into the value of a company and the health of its fundamental trends.
For example, a decrease in accounts payable (outflow) could mean that vendors are requiring faster payment. A decrease in accounts receivable (inflow) could mean the company is collecting cash from its customers quicker.
An increase in inventory (outflow) could indicate a building stockpile of unsold products. Including working capital in a measure of profitability provides an insight that is missing from the income statement.
For example, assume that a company had made $50,000,000 per year in net income each year for the last decade. On the surface, that seems stable but what if FCF has been dropping over the last two years as inventories were rising (outflow), customers started to delay payments (outflow) and vendors began demanding faster payments (outflow) from the company?
In this situation, FCF would reveal a serious financial weakness that wouldn’t have been apparent from an examination of the income statement alone.
FCF is also helpful as the starting place for potential shareholders or lenders to evaluate how likely the company will be able to pay their expected dividends or interest.
If the company’s debt payments are deducted from FCF (Free Cash Flow to the company), a lender would have a better idea of the quality of cash flows available for additional borrowings. Similarly, shareholders can use FCF minus interest payments to think about the expected stability of future dividend payments.
Operating Cash Flow
Operating cash flow (OCF) is a measure of the amount of cash generated by a company's normal business operations. Operating cash flow indicates whether a company can generate sufficient positive cash flow to maintain and grow its operations, otherwise, it may require external financing for capital expansion.
Operating cash flows concentrate on cash inflows and outflows related to a company's main business activities, such as selling and purchasing inventory, providing services, and paying salaries.
Any investing and financing transactions are excluded from operating cash flows section and reported separately, such as borrowing, buying capital equipment, and making dividend payments.
Operating cash flow can be found on a company's statement of cash flows, which is broken down into cash flows from operations, investing, and financing.
Financial analysts sometimes prefer to look at cash flow metrics because they strip away certain accounting anomalies. Operating cash flow, specifically, provides a clearer picture of the current reality of the business operations.
If a company is not bringing in enough money from its core business operations, they will need to find temporary sources of external funding through financing or investing. However, this is unsustainable in the long run. Therefore, operating cash flow is an important figure to assess the financial stability of a company's operations.
Capital expenditures, commonly known as CapEx, are funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, an industrial plant, technology, or equipment.
CapEx is often used to undertake new projects or investments by the company. Making capital expenditures on fixed assets can include everything from repairing a roof to building, to purchasing a piece of equipment, to building a brand-new factory.
This type of financial outlay is also made by companies to maintain or increase the scope of their operations.
Put differently, CapEx is any type of expense that a company capitalizes, or shows on its balance sheet as an investment, rather than on its income statement as an expenditure.
Capital expenditure should not be confused with operating expenses (OpEx). Operating expenses are shorter-term expenses required to meet the ongoing operational costs of running a business. Unlike capital expenditures, operating expenses can be fully deducted on the company's taxes in the same year in which the expenses occur.
CapEx can tell you how much a company is investing in existing and new fixed assets to maintain or grow the business. In terms of accounting, an expense is considered to be a capital expenditure when the asset is a newly purchased capital asset or an investment that has a life of more than one year, or which improves the useful life of an existing capital asset.
Expenses for items such as equipment that have a useful life of less than one year, according to IRS guidelines, must be expensed on the income statement.
Net Issuance of Stock
Net issuance of stock is a way for investors to determine how a company is controlling their shares in the market.
A positive number indicates that a company has issued more shares into the market.
A negative number indicates that a company has bought back shares.
A negative number is interesting, as it can change multiple aspects of a stocks price. As there are less shares on the market, the price is bound to rise. In addition, since there are less shares, the earnings per share of said company will rise.
Some CEOs are given quotas to hit in terms of EPS and buying back stock is an effective way to grow that number and reach that quota, although inorganically.
With a rising EPS, investors can see that on the surface, the company has grown their earnings. However, the company may have just bought back stock and made the EPS rise.
Therefore, net issuance of stock is a very important value. If a company’s EPS is growing, it is important to see if they are growing as a company to reach this or if they have just bought back stock. In addition, an investor can see if a company is contributing to their share price increasing by buying back stock.
The Bottom Line
With these metrics, you are well suited to find new stocks with winning financials. Combining the usage of these metrics as well as the metrics from valuation ratios you can start using will help you screen for stocks with the strongest possible financials.