Everyone agrees it is important to “do your homework” before investing in a company, however this means different things to different people. The common sense goal for conservative investors is to achieve above average returns with below average risk. Our research has shown, the best way to achieve this goal is to invest in strong cash flow companies.

Why is Cash Flow Statement analysis so important?

There are 3 financial statements that public companies file with the SEC: Income Statement, Balance Sheet and Cash Flow Statement. Most investors and investment professionals agree it is important to analyze a company’s financial statements and health (fundamental analysis), but there is a wide range of opinions on which metrics are the best indicators of quality investments.

In today’s world, there is significant pressure on company executives to not only meet, but beat, previous sales and earnings figures. This pressure is created by the market because the ability to generate earnings (profit) plays an important role in stock prices. In response to this, many companies use a strategy called “earnings management” to manipulate the earnings to hit specific targets. This practice helps to smooth out the high and low earnings data to show more consistency. This practice is legal, but may not be accurate.

The practice of “smoothing earnings” is more widespread than ever before. It is vital to look beyond sales and earnings to identify successful investments and avoid the pitfalls of various accounting practices allowed by the Federal Accounting Standards Advisory Board (FASAB). Detailed analysis of the Cash Flow Statement determines the quality of an investment based on a company’s ability to operate their core business in a manner that will increase its value to shareholders. Now more than ever, positive cash flow represents real cash and true profit while earnings do not. We believe earnings are opinions and cash flow numbers are facts. This is why the Cash Flow Statement should be used to validate the quality of earnings.

Cash Flow Statement Analysis Benefits:

• Identify those investments which create the greatest value for investors.
• Reveal the performance of a company’s core operations.
• Validate the quality of a company’s reported earnings.
• Determine if there is free cash flow (cash flow after capital expenditures).
• Verify there is enough free cash flow to pay stock dividends.
• Verify there is enough free cash flow to pay bond interest.
• Verify there is enough free cash flow to pay both dividends and interest.
• Improve communication between advisors and clients.

Take the Tour to learn more about how our website can help you identify quality investments.