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Operating Cash Flow Implications

One of the elements on which the existence of a company depends is its cash. Thus, when deciding on the investment in a particular company you should not overlook a company's cash flow and concentrate only on its earnings per share and net income.

Operating Cash Flow (OCF) represents the movement of money in and out of the company. It is derived from the net income of the company. Various adjustments are made on the working capital accounts that are on the balance sheet.

If more money comes in the company than goes out of it, then the cash flow is positive. If more money goes out of the company, then the OCF is a negative number.

Operating Cash Flow and Earnings

A negative OCF may occur even in cases of positive earnings. This means that the company spends more than it earns. If this is observed in the company from which you have stocks, then you should be aware that something wrong may be going on in the company.

The latter represents one of the factors that differentiate accrual accounting from cash accounting.

So, accrual accounting is typically used by companies. It is preferred by companies, since it gives them a great degree of freedom and flexibility on how and when they will document their income and expenses.

This may result in the coverage of short-term problems. However, this doesn't solve them and sooner or later the company will have to face the roots of the problem that cause the cash drain.

OCF is useful for identifying companies that spend more than they actually earn. In this way you eliminate the need to study the company's net income and earnings per share, since a negative number in the OCF category indicates problems within the company no matter what its other indicators may show.

The exact company's OCF can be easily found in the balance sheet of the company. It is in the statements of the cash flow and you should select companies with positive numbers. However, if the numbers are negative try to find the reason why and see whether investing in this company will represent a risky enterprise.

If you don't have time to search for the balance sheet of the company, you can use the price-to-cash flow (P/CF) ratio. It is calculated on the basis of the current stock price. What you should remember is that you should look for a positive number.

P/CF is convenient to use since it can be applied in the stock screeners. As a result even before you start cash burners are eliminated from the picture. Additionally, comparison between peer companies is facilitated.

Final Piece of Advice

Keep in mind that OCF has its negative sides and drawbacks. However, when used wisely it provides for a useful tool for deciding on the viability of a company. You should use it in combination with other criteria when selecting the right stock for you.

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