The Importance of Operating Cash Flow

Operating cash flow is a financial metric that is often used to gauge the investment potential of a company. The operating cash flow of a company tells investors how much money is left over after a company pays its bills. Here are some of the basics of operating cash flow and why it is so important.

Operating Cash Flow

Operating cash flow is a measure that is used to gauge how much money is flowing into and out of a particular company. The number is different from net income although it is very similar. If a company has a positive operating cash flow, this means that it is bringing in more money than it is sending out. If it has a negative operating cash flow, it means that the company is spending more money than it is making.

Nowhere to Hide

One of the good things about operating cash flow is that it prevents companies from manipulating financial information. With net income, companies have some flexibility that allows them to manipulate this number. They can decide when they want to report certain expenses and incomes. This could allow a company to show a positive net income and have a negative cash flow at the same time. Companies with positive net incomes could simply be trying to change the numbers around so that it appears that they are still profitable even though they are experiencing serious problems. Sooner or later, these companies will not be able to keep up the charade and default may be next.

Thanks to standard accounting rules, operating cash flow is not something that can be manipulated by company accountants. When the financial statements are released by the company, investors can calculate the operating cash flow without any troubles.

Pattern

If you are an investor, you should be looking for patterns in the businesses that you invest in. Before putting your hard-earned cash into the stock of a particular company, you want to make sure that the company has a track record of having positive operating cash flow. Conducting a cash flow analysis over the last month or quarter is not going to be good enough for savvy investors. A company could have simply had a good quarter. If that same company has had several years of negative operating cash flows, you should still be very skeptical about investing money into them. Once a company gets in the habit of spending more money than it brings in, it can be very difficult to break the cycle. Patterns of this nature are usually a good indicator that a company will be heading towards default at some point in the future.

Big Picture

Just because operating cash flow is a valuable tool to use, that does not necessarily mean that you should look at it independently. You should still look at other important financial metrics such as earnings-per-share and net income. Using all of these valuation multiples together can improve your odds of choosing winning companies to invest in.

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