Cash Flow the Easy Way: Analysis

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Analyze Cash Flow The Easy Way
January 17 2007 | Filed Under » Stocks If you believe in the old adage, "it takes money to make money," then you can grasp the essence of cash flow and what it means to a company. The statement of cash flows reveals how a company spends its money (cash outflows) and where the money comes from (cash inflows). (To read more about cash flow statements, see What Is A Cash Flow Statement?, Operating Cash Flow: Better Than Net Income? and The Essentials Of Cash Flow.)

We know that a company 's profitability, as shown by its net income, is an important investment evaluator. It would be nice to be able to think of this net income
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While often coming close to net operating cash flow, this professional 's short-cut can be way off the mark and investors should stick with the net operating cash flow number.

While cash flow analysis can include several ratios, the following indicators provide a starting point for an investor to measure the investment quality of a company 's cash flow: Operating Cash Flow / Net Sales: This ratio, which is expressed as a percentage of a company 's net operating cash flow to its net sales, or revenue (from the income statement), tells us how many dollars of cash we get for every dollar of sales.

There is no exact percentage to look for but obviously, the higher the percentage the better. It should also be noted that industry and company ratios will vary widely. Investors should track this indicator 's performance historically to detect significant variances from the company 's average cash flow/sales relationship along with how the company 's ratio compares to its peers. Also, keep an eye on how cash flow increases as sales increase; it is important that they move at a similar rate over time.

History of Free Cash Flow: Free cash flow is often defined as net operating cash flow minus capital expenditures, which, as mentioned previously, are considered obligatory. A steady, consistent generation of free cash flow is a highly favorable investment quality – so make sure to look for a company that shows steady and growing free cash flow
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