Are you ever confused by the different types of cash flow for investment analysis? I know I get them confused and I’m a seasoned investor. However, cash flow calculations provide information on profitability, quality of earnings, liquidity, risks, capital requirements, future growth, dividends, etc. They are one of the most valuable tools for investment analysis available to investors looking at investment opportunities.
Cash Flow for Investment Analysis
Cash flow analysis is the examination of cash inflows and outflows. It is normally measured for a specific period of time (i.e. one year). Investors looking at investment opportunities need to know: Is the entity generating enough cash to sustain its’ business, grow its’ business, and provide returns to stakeholders? Cash flow calculations provide information on profitability, quality of earnings, liquidity, risks, capital requirements, future growth, dividends, etc.
I have put together a summary of the different types of cash flow calculations for investment analysis:
Different Types of Cash Flow
Let’s start with the three types of cash flow in a Cash Flow Statement:
Cash Flow from Operating Activities
Measures the cash generated from the core business or operations of the business. The calculation is operating income before depreciation minus taxes and adjusted for changes in working capital.
Operating Cash Flow (OCF) = Operating Income (revenue – cost of sales) + Depreciation – Taxes +/- Change in Working Capital
Cash Flow from Investing Activities
Measures the cash flow of an entity’s investing activities, including items such as capital expenditures, acquisitions, or investments in other securities such as government bonds.
Cash Flow from Financing Activities
Measures the cash flow from financing activities, including issuing or buying back stock, issuing or repurchasing debt, and paying dividends to shareholders.
Note: These 3 cash flows are segregated and detailed in the Statement of Cash Flow. The sum of the three makes up the Total Cash Flow for the entity.
Total Cash Flow
Cash Flow of the entity is the sum of the Cash Flow from all activities including operating, investing, and financing activities. The Cash Flow of a period of time will equal the difference between the entity’s cash balance at the beginning and ending of the time period.
Net Cash Flow
Net Cash Flow is the profits (or loss) of the entity plus non-cash expenses (i.e. depreciation and amortization). Net cash flow includes the financing and investing activities that are included on the income statement, but excludes financing and investing activities affecting the balance sheet.
Free Cash Flow
Free Cash Flow is operating cash flow less capital expenditures. It is the cash available to debt and equity holders after the expenses and taxes are paid and capital expenditures have been deducted.
Net Free Cash Flow
Net Free Cash Flow is Free Cash Flow less the current portion (amount to be paid over the next year) of capital expenditures, long term debt, and dividends).
Cash Flow is one of the most important investment concepts to understand. Each one of the different cash flow metrics gives pertinent insight into the health of an entity. Learn the types of cash flow for investment analysis and you will be greatly improving your ability to analyze investment opportunities.