Free Cash Flow

I don't normally talk about investing because, well I'd be out of my league. Rather than focus on stocks, I focus on simply buying good businesses for the long-term. I am quite capable of reading financial statements (and if I don't understand something, well Mrs. Businesspundit is an auditor so I nag her about it), and that is why I like this article.

The whole point of investing in a business is to get more money out than you put in. That basic tenet is sometimes lost on investors and corporate managers obsessed with growth. Businesses need cash to grow. They also need cash to pay salaries, research costs and dividends. As an investor, you want to know whether your company can afford to do all these things. Net income may not tell you this, but free cash flow will.

When it comes to cash, which companies actually use to meet their obligations, net income is not really the bottom line. Net income can be skewed by non-cash gains or charges. Cash provided by operations (CPO) provides a good check on reported earnings, since it involves fewer assumptions.

One thing you will rarely see here is stuff about earnings announcements. Why? Because too much of it is bullshit. I had a professor in a B-school accounting course who used to love pointing out to us ways that companies manipulating earnings. Thus I am always suspicious of EPS numbers. Cash flow is much harder to manipulate, and it is important to understand it as an investor or a manager. It is amazing to me how many businesspeople don't understand that money has a time value. Learn to manage cash flow, and you'll see higher profitability as well.

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  1. sebastian's Gravatar Comment by sebastian on October 20th, 2006 at 11:36 am

    Quisiera poder integrarme a el equipo de como poder ser un millonario ç:)

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