Net Cash Flow is the profits of the business plus non-cash expenses. Net cash flow, also referred to as cash flow earnings or Net Income Plus Depreciation (NIPD), is not the same as Net Profit. Non cash expenses lower the amount of net profit but do not reduce cash flow.
Net Cash Flow Calculation
Net Income + Non-Cash Expenses = Net Cash Flow or Cash Flow Earnings
Items such as depreciation, depletion, and amortization reduce Net Profit but are only accounting entries. These are non-cash items that do not reduce cash flow. Therefore these items are added back to Net Profit to obtain Cash Flow Earnings. Note: Operating Cash Flow would also consider short term changes in current assets and current liabilities. Net Cash Flow does not.
Why is Net Cash Flow Important?
Net Cash Flow is important because it tells an investor how much cash a company is generating. After a company creates a product or service and pays all of its bills, the cash flow earnings is the cash the business has available to make money for the shareholders.
Management has three choices for its cash flow earnings (Net Cash Flow); invest for future growth (buildings, equipment, inventory, etc.), pay off debt (reduces future interest expenses and improves the balance sheet), or return money to shareholders (dividends and stock buybacks).
The priorities of these company choices will change over time. But cash flow earnings give an analyst the important metric: the amount of cash generated. The next step is to evaluate the effectiveness of managements decisions. Have past cash flows been reinvested so that cash earnings are growing? Is debt being reduced or managed efficiently? Are earnings being returned to shareholders?
Net Cash Flow is a good metric to compare different companies. It is one of my favorite because it is simple and effective. Its’ best use may be to use in ratios with other metrics.
My favorite is Return on Enterprise Value (ROEV), which compares net cash flow to enterprise value. I run this calculation on every stock I research. If I could only use one metric to choose a stock, this would be the one!
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