4 ways to measure a company's cash flows

A company's cash flows are a fundamental measure of a company's financial health. They are an essential tool for evaluating a company's ability to meet its short-term financial obligations, as well as to invest in its future growth. The calculation of cash flows is relatively simple and can be divided into different categories that we are going to see in this article.

What are cash flows?

The cash flows of a company are a fundamental measure of the financial health of a company. This is the amount of cash that comes in and out of a company in a given period. These flows They can be positive or negative, depending on whether the company is generating or spending more cash than it is receiving.

What are cash flows for?

Cash flows are an essential tool for evaluate a company's ability to meet its short-term financial obligations, as well as to invest in its future growth. In other words, cash flows provide important information about a company's solvency and liquidity. In addition, cash flows are also important for investors, as they allow them evaluate the profitability of an investment in the company. Investors want to know if a company is generating enough cash to pay dividends and, if so, how much those dividends are expected to grow in the future.

icons

Formula to calculate the net cash flow of a company. Source: WallStreetMojo.

How cash flow is calculated

Calculating cash flows is relatively simple and can be divided into three categories: operating cash flow, investing cash flow, and financial cash flow.

  1. Operating cash flow: refers to the amount of cash a company generates through its daily activities. This includes the cash you receive from the sale of goods or services, less the operating expenses necessary to produce those goods or services.
  2. Investment cash flow: refers to the amount of cash a company spends on long-lived assets, such as purchasing equipment or building a new plant.
  3. Financial cash flow: refers to the amount of cash a company spends or receives in connection with its financing, such as paying dividends to shareholders or issuing new shares or bonds.

Most popular ratios to measure a company's cash flows

We can find different ways to measure the cash flows of a company, but the most popular are the ones we are going to mention below:

Net present value (NPV):

It is the method used to evaluate the profitability of an investment project. It is calculated by subtracting the present value of future cash flows from the initial cost of the project. A positive NPV indicates that the project is profitable, while a negative NPV indicates that the project is not profitable.

Internal rate of return (IRR):

Another method used to evaluate the profitability of a project. It is the discount rate that equates the present value of future cash flows with the initial cost of the project. If the IRR is greater than the required discount rate, the project is profitable.

Profitability index (RI):

Method used to evaluate the relationship between cash flows and the initial cost of the project. It is calculated by dividing the present value of future cash flows by the initial cost of the project. If the IR is greater than 1, the project is profitable.

Price/free cash flow:

Capital valuation method used to compare a company's market price per share with its free cash flow per share (FCF) amount. It is calculated by dividing the price of a company's shares with its free cash flow per share. If a company's P/FCF is lower than the average for its sector or industry, it may indicate that the company is undervalued.


Leave a Comment

Your email address will not be published. Required fields are marked with *

*

*

  1. Responsible for the data: Miguel Ángel Gatón
  2. Purpose of the data: Control SPAM, comment management.
  3. Legitimation: Your consent
  4. Communication of the data: The data will not be communicated to third parties except by legal obligation.
  5. Data storage: Database hosted by Occentus Networks (EU)
  6. Rights: At any time you can limit, recover and delete your information.