| Continuing our discussion on cash flow 101, I feel | | | | interest expense is deemed to vary depending on |
| that cash flow discussion is not complete without | | | | a firm's capital structure. A firm may pay more |
| digging further into operating cash flow. To | | | | or less interest expense due to the amount of |
| refresh your memory, operating cash flow is the | | | | debt it holds, not due to its operating efficiencies. |
| cash flow generated by a firm's business activities. | | | | Finally, depreciation and amortization is the |
| Business exists to produce cash flow. Therefore, | | | | subtraction of long term asset purchased outside |
| we prefer business that spots a positive cash | | | | of the accounting period. Therefore, no cash |
| flow. | | | | actually flows out of the coffer during the period. |
| We do invest in companies that produce negative | | | | Let's take a look at a typical cash flow statement |
| cash flow in certain ocassions. For example, this is | | | | for Merck & Co Inc. (MRK). For the fiscal year |
| the company that is growing rapidly and in order | | | | ending on December 2006, Merck reported net |
| to create barrier of entry, the company is | | | | income of $ 4.34 Billion. Operating cash flow |
| investing heavily while business hasn't picked up. | | | | meanwhile, was reported at $ 6.77 Billion, mainly |
| An example of this scenario is: biotech companies | | | | due to $ 2.27 Billion addition of depreciation. There |
| that spend money on Research & Development | | | | is also adjustments due to change in liabilities and |
| or retailers giving away free shipping to gain | | | | or inventories as well as account receivables. That |
| customer loyalty. | | | | is a given. When you do X amount of sales but |
| There is also a little thin line of classifying expense | | | | you did not get cash back (a.k.a bulging account |
| of between operating cash flow and say investing | | | | receivables), your operating cash flow would be |
| cash flow. A retailer that is giving away free | | | | affected. There is also a line called 'Adjustments |
| shipping might experience a positive operating | | | | to Net Income', which is not clear from the |
| cash flow but negative investing cash flow if it | | | | example above. For the most cases, however, |
| feels that the free shipping is a long term | | | | cash flow generated from operation is a higher |
| investment to create barriers of entry. However, | | | | figure than the net income figure. |
| for the most part, that kind of expense will fall | | | | Now, how would cash flow from operations help |
| into operating cash flow since it relates to the | | | | us in investing in stocks? In the absent of |
| daily part of the company's business. | | | | dependable cash flow from operations, we prefer |
| Now, what constitutes a positive cash flow from | | | | to invest in companies that have positive net cash |
| operations? Generally, we work our way back | | | | on their balance sheet. This means more cash on |
| from the income statement. From the net | | | | hand than it has debt. If a firm has dependable |
| income, we have to add depreciation and | | | | huge cash flow from operations, it can |
| amortization, interest expense and taxes. This is | | | | compensate for the lack of strength in its balance |
| because, theoretically, a firm is not required to | | | | sheet (i.e: less cash than long term debt). |
| pay taxes if it reported a net loss. Furthermore, | | | | |