When investors are analyzing whether to look at company they often focus on the income statement and whether the company’s sales are growing and whether it is profitable. However, there are things that could distort the usefulness of those numbers, such as if the company is only profitable due to foreign exchange gains or tax recoveries.
Profitability and sales are important, but there are other things investors should consider. Whether a company is able to bring in cash from its operations shouldn’t be overlooked, and if it isn’t it, that could be the first sign of trouble.
This is especially true in the oil and gas industry where we’ve seen many bankruptcies since the price of oil crashed, and as a result many receivables may not be collectable which will have an impact on a company’s cash flow.
Another area to look at is the company’s capital expenditures. A company that is reducing its investments isn’t going to have strong growth prospects and it could be a sign of trouble since that is often one of the first places for a company to cut costs.
What’s left over after the company’s capital spending is its free cash, and this is important because this is essentially how much money the company has left over after running its business. If a company is growing free cash that is a good sign and indicates that it is in a good position to take on big investments down the road, perhaps even an acquisition.
Sales and profits are good long-term indicators that the company is doing well, but in the short term you shouldn’t overlook a company’s cash flow.