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Cash Flow Analysis

Another important tool to add to your investment toolbox is cash flow analysis. Because we are all not financial analysts (thank your god), for our purposes we will simply define cash flow as the sum of a company's net income plus depreciation and deferred taxes. We add back or include depreciation because it is a non-cash item used for accounting purposes on a company's income statement. Essentially, we are left with the funds a company actually produces and has at its disposal (not including any lines of credit) to conduct its daily operations. Cash flow is considered an especially appropriate indicator for capital-intensive companies, which incur high outlay costs to "get things rolling", but then experience smaller outlays as their business progresses. Examples of these corporations include, oil and gas, cable, telecommunications, and real estate companies.

The Benefits of Internal Cash Flow

Although income from discontinued operations can be included, our definition of cash flow is largely calculated on an operational basis and does not include cash obtained through a financing. As a result, it is a solid measure of a companies ability to grow internally, without borrowing cash or going to the equity markets in a possibly dillutive (issuing more shares) fashion to raise funds for expansion or an operational upgrade. Thus, operationally cash rich corporations are usually considered less risky. Indeed, companies which generate substantial internal cash flow from operations, are in a solid position to use the proceeds to your (shareholder) advantage. Below are six beneficial ways a company can use its cash flow.


Companies with good cash flow can often build up a "war chest" for the purpose of acquiring other businesses. Acquisitions are often an effective means through which corporations can expand, diversify, and/or sustain above average levels of growth. Each of these objectives, if fulfilled, are positive for the company and can result in higher returns, which should make you, the shareholder, quite happy.

Pay Dividends

Of course, companies producing solid cash flow are in a position to reward shareholders with cash payments known as dividends. Having said this, dividends are not always the best use of funds in certain situations. For example, in the case of growing corporations, it is often a wise decision to invest all or most excess cash back into the company for expansion, R&D, or other growth initiatives.

Increase R&D

For many corporations, excess cash is well spent on research and development. This strategic reinvestment is often of critical importance to the future success of technology based companies, whose competitive advantage lies in staying one step ahead of the competition. Indeed, with cash on hand, a corporation is in a great position to continually ensure that its people and equipment remain on the cutting edge of its industry.

Upgrade Plants and Equipment

Of great importance to manufacturing and many service corporations is the proper and efficient functioning of its plant and equipment. Maintaining good cash flow will ensure that a corporation is well positioned to not only sustain current conditions, but upgrade, and even purchase more efficient plants and equipment when it is deemed necessary to do so.

Pay Down Debt

Another option available to a corporation with solid cash flow is to pay down existing debt. Because most debt requires regular service payments, it is often a good decision to eliminate the burden of these payments by repaying all or a portion of the outstanding amount. This one time payment can decrease the term or eliminate the balance of a loan completely, and lead to an increase in future cash flow.

Buy Back Shares

In certain situations, a corporation may use its excess cash to purchase a number of its common shares back. This purchase on the open market known as a Normal Course Issuer Bid, usually entitles the corporation to purchase approximately 5 percent of its outstanding common shares within a specified period (usually one year). Corporations will "buy-back" shares through this message when they feel their shares are being undervalued or offer good value in the market. The purchase and simultaneous retirement of shares to a company's treasury, reduces the amount of shares outstanding and, in turn, increases the value of the remaining shares.

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