If cash is king, then why the hell do we use earnings per share during quarterly reports? Today, we discuss cash flow versus earnings: what’s their definition, their differences, and how to use them in your stock analyses.
Listen now to assess the health and wealth of your buy list more easily!
You’ll Learn
- Why earnings are not equal to net income and what they really are.
- What’s the real definition of Cash Flow and why it is important to follow it.
- Why Cash Flow is not included in the companies’ quarterly reports top highlights.
- At what stage of your analysis should you use earnings and at which should you look at cash flow.
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Related Content
During the episode, Vero mentioned the different layers of stock analysis. Payout ratios are connected to cash flow and earnings and should be included in your process. But which one should you use? What’s a good payout ratio and what does it tell you exactly? Become a master of payout ratios, listen now!
At any time, you can also go back to the Dividend Triangle episode here.
How to calculate cash from operations
Here’s the simple formula to calculate where the cash from operations number comes from:
Cash from operations = Net Income + Non-Cash Items + Changes in Working Capital
The Net Income could also be named earnings (earnings are net income after taxes). This is the accounting profit.
You then must add all non-cash items such as capital appreciation or depreciation, amortization, investment gains or losses, that do not involve a cash payment. For example, a company could report a $100M amortization on a building or a $250M value impairment on a brand value that is not doing so well. Those movements will reduce the company’s net income but will not affect the cash in its bank account.
Finally, the changes in working capital (the difference between current assets and current liabilities) are one of the major ways that net income and operating cash flow can differ. A company is investing in assets or becoming less efficient when the change in working capital is negative and depleting assets or becoming more efficient when the change in working capital is positive.
If you don’t feel like playing with your calculator, you can just go directly to the company’s earnings statement and get the metric calculated for you.
What really matters is that you understand that cash from operations is telling the real story behind the company’s business model. A company could report positive earnings by being too loose on accounting rules, but it can’t lie if the bank account is bleeding cash.
You can see cash from operations as the blood pumping through your veins. It enables all your body parts to function normally and contribute to your well-being. When a company is running out of cash flow, it misses on blood to nourish its business arms.
That said, remember that cash flow fluctuates a lot and it is only normal.
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This podcast episode has been provided by Dividend Stocks Rock.
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