Some of you may have noticed this comment from Mark a few days ago:
I have been unable to find an answer about how to calculate cash flow. Specifically that when i subtract “Purchase of Fixed Assets” from “Cash from Operating Activities”, PoFA is a negative number. so for example, MDT 2007 is: 2979-(-573)= 3552 ???? As an engineer i have a hard time dropping signs. Please help. Thanks, Mark
Here’s what Phil told him, for those of you who may have a similar question:
First make sure the business has a great moat. If it does, then it’s fine to use Operating Cash Flow numbers. It’s the first major line in the cash flow statement, usually about a third of the way down from the top.
You’ll see that for good moat businesses, it’s a lot more consistent number for cash flow than free cash and therefore a lot more useful to use to compare cash with earnings, equity and sales.
Free cash is important to watch because some businesses use up all their cash all the time just replacing equipment, so even though they are profitable, the owners have to shove the profits back in to keep the doors open. It’s a kind of false profitability…
But if a business has a great moat, yet free cash is all over the place, probably they are using cash to open new stores and grow. Nothing wrong with that.
Bottom line, if you are looking at one of those bouncy free cash flow businesses, use the operating cash flow numbers to get a better idea of what’s happening with the growth of cash.
FAQ: How do I calculate a growth rate using negative numbers?
FAQ: Where do I go to find Free Cash Flow on MSN?
Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.