Tuesday, May 12, 2009

Cash Flow Analysis, pt 2 - CFI

[Cash Flow Analysis Series 1 CFO - 2 CFI - 3 CFF - 4 FCFF - 5 FCFE]

Cash flow for investing is an interesting metric to look into. When compared to CFO, it provides some perspective as to the future prospects of the company (how much the company is investing in its future). It is a simple calculation where expenditures (investments) in new assets are subtracted from the proceeds of asset sales.

Very simply:

CFI = Σ Individual Cash Flows for Each Asset Purchased (Sold)
Cash Flow for Asset Purchased (Sold) = Book Value of Asset + gain (loss) on sale

CFI accounts for the net effect of investing cash flows where investment in new assets is cash out (capital expenditures) while the sale of assets is cash in.

Note that CFI directly affects the book value of the company and can be used to incrementally determine the change in book value for a P/B valuation model. Obviously, however, there are liquidity issues which arise and benefits from management skill (alpha).

Also note that CFI contributes directly to NI (and why it is subtracted in the indirect method of determining cash flow from operations, CFO). Recall that if in lean times a company sells assets, it will report higher net income (and therefore retained earnings and earnings per share will be higher), however, this business practice is not sustainable and can be used by management to "smooth" EPS reporting.

[Cash Flow Analysis Series 1 CFO - 2 CFI - 3 CFF - 4 FCFF - 5 FCFE]

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