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Dec 27 2008

Net Income Over Cash Flow

Posted by admin in finance2

Some Financial Analysts argue that using cash flow will provide a more accurate picture in determining the fair value of a common stock. What gives? They reason that investors should follow where the cash is. Cash flow will track the flow of cash in and out and this is the reason business exists; to get cash.

Things are not that simple, however. Just as net income, cash flow can be easily manipulated. Cash flow here refers to cash flow from operations found on the statement of cash flow published regularly by publicly traded companies.

Let’s take a look at the statement of cash flow for one publicly traded company, Amazon.com (AMZN) and decipher its components. We will use the statement of cash flow for the year ending on 31 december 2004. Here is the source from Yahoo! Finance: http://finance.yahoo.com/q/cf?s=AMZN&annual

The top part is net income, which is self-explanatory. This is what a company earns during a period of time. For the time period earns $ 588 M. To get into the cash flow figure, we need to add depreciation expense, subtract any increase in accounts receivable and inventory and add any increase in short term liability such as accounts payable. Sometimes, there will be some adjustments made to the net income which will increase or decrease cash flow depending on the charge.

Now here is how companies can manipulate cash flow. This will in effect temporarily give an impression that cash flow has improved markedly.

Temporarily Delaying Payment. This will increase Accounts Payable which in turn will improve cash flow. While only good companies can demand its suppliers to delay payments, all the debt eventually needs to be paid.

Demanding faster payments from customers. While an efficient collection is needed for a firm’s survival, giving less credit to customers will result in them balking away. In the short term, cash flow will improve due to improved collection. In the long run, customers will go to competitors who can offer better credit.

Keeping a tight supply of inventory. While bloated inventory is wasteful, there is a certain level of inventory that is needed to keep a business running. Short-minded management will try to manipulate cash flow by keeping a short supply of inventory. When you run a retail business, certain inventory is needed. It is not similar to a built-to-order company like Dell Inc. (DELL).

These three items vary from quarter to quarter and year to year. When determining fair value, it is best to ignore these fluctuations and focus on operational earnings generated by the company.

Another misleading cue from cash flow is that it adds up depreciation as the amount of cash generated from operations. While depreciation expense is a non-cash transaction, it is a necessary cost of doing business. For example a company bought a computer and depreciate it for five years. For the next five years, the company incur a non-cash charge, which is the reason why we add depreciation expense to our cash flow. However, we need that computer for our operational purpose. Unless we stop spending in our capital expenditure, adding depreciation expense to our cash flow does not make sense. Sure, you enjoy the benefit now. But five years from now, you need to spend money on a new computer, which is a cash outflow.

As with other investing tools, cash flow from operations cannot be used independently of other ratios. Each and every financial ratio has its strengths and weaknesses. I believe that cash flow does not reflect the true earning power of a company because of short-term fluctuations of the balance sheet and the addition of depreciation expense into a firm’s cash flow.

Come get your free investing idea by regularly visiting our commentary section at http://www.noviceinvesting.com

Tags: Annual Report, Balance Sheet, cash flow, finance, investing, Portfolio, stock

Invest Now for Dividends Later

Posted by admin in finance2

No matter what age you are or even your level of employment or economic position, it may be a good idea to start preparing now, even in a meager way, for eventual financial security. Some people feel they need every dollar they make to get by from one paycheck to the next. While this may be true for some, there are others who squander significant sums on insignificant things. They could be socking that money away into an investment account that, over time, could lead to huge savings and a comfortable retirement.

It isn’t hard to get started. All you need is $100 to $500 to open an account, and anywhere from $25 to $50 monthly to continue building your stock or mutual fund portfolio. In fact, a young person aged 20 could deposit $2,000 and then not another dime. In forty years he or she might have tens of thousands of dollars. The stock market has followed fairly predictable patterns since its inception in the 1800s in New York City. Although historic events like the Great Depression and several global wars have impacted its activity, the gains and losses remain fairly consistent, with most investors earning a predictable return on their investment.

Of course, no one can predict what the future holds, or whether the pattern will continue. And none of us should invest more money than we can afford to losejust in case the world economy crashes one of these days. But with steady deposits that continue to compound and earn interest over time, a sensible and prudent investor can substantially increase the amount of money going for retirement or a dream vacation at some future point.

If you are thinking about opening an investment account, do a little online browsing for more information. Visit sites like E-trade or Scott’s Trades to see how the process works. Start reading your newspaper’s financial pages for details about the latest stock prices and market trends. Do a little paper trading by following the daily stock news. Instead of actually purchasing stock, however, work it out on a piece of paper by pretending to buy a certain amount of stock for the specified price and then watching to see how it performs over the following week. Chart your gains or losses to figure out whether your stock deal was successful. If you do this for several months, you will soon learn to understand more about the stock market and how to buy and sell like the pros.

Even if your budget is tight, try to set aside a little money to open an investment account from any windfalls that come your way from job bonuses, inheritances, or cash gifts. Some people set aside their annual job raise, or part of it, as part of their investment strategy. Then, as your budget becomes looser with paid-off bills or grown-up kids, you may be able to start having a standard monthly amount deducted automatically from your paycheck and deposited into your investment account. This could take the form of a Roth IRA (individual retirement account), a money market fund, a mutual fund portfolio, or individual stock shares.

It probably is a good idea to take an investment class at the community college or sign up for a financial planning seminar. Success may be just a few years away if you start now and plan right.

You can find more great investment information at http://www.investment-central.com

Tags: account, Budget, financial.finance, invest, investment, money, Portfolio, saving, savings, shares, stock

Time To Reshuffle

Posted by admin in finance2

Is it time to juggle your portfolio? Perhaps. The year end is less than two months away. I have elaborated on the importance of fall season as the best time to rearrange your portfolio. Mainly, stock that rises during the year will continue to rise heading into year end. On the other hand, stock that underperformed, will continue to be sold heading into year end.

Now, the year end is almost here. While there are no guarantee that you can buy at the best possible price, it is as close as you can get. Stock does not turn exactly on the last day of the year. Even when it does, investors will anticipate its movement and make any arbitration move useless. But, the November- December period is close enough for small investors to get the best possible price.

Having said that, I don’t advocate buying any stocks that fall sharply during the year and selling any stocks that have risen a lot. Fundamental still drives stock price movement in the long run. Therefore, what you need to do first is to determine the fair value of a common stock that you want to invest. I have touched on this subject briefly in the past too.

If you are looking to invest, you can start researching stocks that have fallen throughout the year. Until year end, these stocks will continue to be depressed. Here are several list to help you look. Fannie Mae (FNM), Lexmark (LXK), Pier 1 Imports Inc. (PIR), Sharper Image Corp (SHRP), Seagate Technology (STX), JoAnn Stores (JAS), Take Two Interactive (TTWO) and Flagstar Bancorp (FBC).

If you own one of these stocks, you might want to continue holding them until the year ends. This way, you will pay taxes for fiscal year 2006 instead of 2005. Here are several list: Apple Computer (AAPL), TXU Corp. (TXU), NVIDIA Corp. (NVDA), Tesoro Petroleum (TSO) and Valero Energy (VLO).

You can get your free investing idea by visiting our commentary section at http://www.noviceinvesting.com