Investors can be lured by big profits and solid earnings surprises this earnings season. But looking beyond profits and assessing a company’s cash position can be far more rewarding. This is because, even though profit is a company’s goal, cash is the lifeblood for its existence, development and success, and indeed a measure of its resilience.
In fact, even a profitable business can succumb to failure if its cash flow is uneven and eventually file for bankruptcy. But a company with healthy cash position has the capability to effectively tide over any market mayhem and still be on the growth curve, besides enjoying flexibility to make decisions, chase potential investments and run its growth engine.
To find out the efficiency of a company, one needs to consider its net cash flow. While, in any business, cash moves in and out, it is net cash flow that explains how much money the company is actually generating.
A positive cash flow indicates an increase in the company’s liquid assets, which provide the means to meet debt obligations, shell out for expenses, reinvest in business, endure downturns and finally return wealth to shareholders. On the other hand, negative cash flow indicates a decline in the company’s liquidity and in turn lowers its flexibility to support these moves.
However, positive cash flow alone is not sufficient to predict a company’s growth. A company can competently grow only when this positive cash flow is rising, because this improvement indicates management’s efficiency in regulating its cash movements and lesser dependency on external financing sources for running its business.
So, while picking stocks, look beyond profits and select companies with dependable and increasing cash flows.