A projecting cash flow statement is one of the most important documents that an investor must learn to read. Statements show a glimpse into a business’s finances and show the true financial health of the operations.
Many businesses have impressive revenue figures and suffer from poor cash flow.
If an investor finds that cash flow is too low, it is a major red flag. Without adequate cash flow or projections of it, the business must finance operations through other methods, such as:
- Fundraising rounds
Every business needs some form of cash flow or injection if it wants to reach its potential. Investors can use these projections as a method of comparing investments and reducing risks.
How To Evaluate A Company’s Cash Flow Projections: Tips For Investors?
Informed investment decisions start with evaluating cash flow investments. A cash flow projection statement has a wealth of information that you may or may not understand how to read.
When reviewing the statement, you should look for the following metrics:
- Overall cash flow. Does the company have a positive cash flow? If not, it doesn’t have the finances to grow and maintain operations. Of course, if it’s a startup with a lot of funding and potential, you may be able to overlook this discrepancy because funding rounds will help keep the company solvent.
- Negative cash flow. If the business has negative cash flow, this is an indication that it’s spending more money to improve or keep operations going than it has available.
- Operating cash flow margins. These margins will show how sales are converted to cash and at what ratio.
Projections will help you analyze how the company may improve during the projection period. If you find that expenses drop drastically in the projection, you can ask management why. Do they plan on shuttering a segment of the company or is a loan being paid off?
The statement will also include a total cash inflow and outflow, which you can compare to previous statements to learn the trajectory of the company.
The Role Of Cash Flow Projections In Portfolio Management: Why Projecting Cash Flow Is Important For Investors
A projecting cash flow statement is an invaluable tool for investors because it will answer the following questions:
- Does the company have enough cash flow to pay its dividend to investors or buy back shares?
- Does the company have enough cash flow to be able to grow operations?
- Will the projected cash flow be enough to pay for all outflows?
If you’re an investor and realize that over the next year or two, the company will not have positive cash flow, you should be concerned. Without cash flow, growth initiatives will stall and it will be difficult to increase stock value.
You want your investment to have a strong return, and it’s almost impossible to have a major return with negative cash flow unless:
- The company is part of a major acquisition
- Future funding is in the works
Otherwise, investing in the business may not be in your best interest, especially if no one can demonstrate how the business plans to hit milestones with zero or negative cash flow.
How To Use Cash Flow Projections To Value A Company: A Practical Guide For Investors
Portfolio management is a crucial part of investing, and you should spend time valuing a company. The cash flow projection will provide you with crucial information, such as:
- Free Cash Flow, or FCF, which is how much cash flow is left after all of your capital expenditures are taken into account. The FCF tells investors if the company has enough money to pay for share buybacks or through dividends. You can subtract capital expenditures from operating cash flow to get this figure.
FCF is an essential metric when determining a company’s value, but it’s only one piece of the puzzle. The figure has residual value and will ultimately depend on the management of the company.
If managers do not leverage FCF properly, the company may not hit its growth targets.
Valuating a business will require you to determine net operating cash flow, which already has all of the capital expenditures deducted.
Using the valuation and growth of the company’s investments, it will be easier to determine if the investment is worthwhile. The intrinsic value of the business may be what its stock is worth, but if the projections show growth of 10% over the next reporting period, you can use this percentage to better understand the future value of the company.
Portfolio management is integral to being a successful investor. If you follow the tips above, you can dive deeper into the financial statements of the business to better understand its financial health.
Cash flow projections can help you mitigate risks and make smarter, more lucrative investments today and in the future.
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