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Importance of managing cash flow

Bullionstar

Bullionstar

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When investors have some monies in hand, one of the most difficult decisions to make is how to use the fund efficiently and effectively. Should you use the money to pay off your outstanding housing loan or car loan? Or should you top up your CPF accounts? Is it a better option to use the money to invest in shares than generate better returns than saving deposits? Or should you invest in a second property to produce a fixed income for your retirement?

cash flow

In any case, there is no right or wrong answer. But my personal strategy is to maintain a healthy cash flow and I don’t like to pay off all my loans and be debt-free. Having some amount of money in hand allows me to invest in appropriate instruments when the opportunity arises and also cover needs during emergency times. But I always make it a point to clear all my credit card bills on time to avoid incurring late payment charges and interest fees.

But just what is cash flow and why is it important to manage it? From an equity investor’s point of view, free cash flow within a company is the balance of money remaining after the operating expenses are deducted.

Most investors, when reviewing the financial statement of a company, tend to look at the Profit and Losses segment or the Balance Sheet first. For me, it is a given that the financial health of a company should be positive and that the company should be making at least five years of increasing profits.

However, beyond the above, the more important metric I look out for is the net cash from operating activities in the Consolidated Statement of Cash Flow.

Take for example CWT Limited, one of the SGX listed companies that primarily provides logistics services in Singapore. In its annual financial statement released in February 2015, the company announced a glowing profit after taxation of $113.8 million for FY2014, compared to $108.1 million in previous financial year.

However, upon closer examination at the net cash from operating activities, FY2013 revealed a whopping negative of $390 million in FY2013 as compared to a positive of $296 million in FY2014. This huge erratic change in working capital was not convincingly explained in detail by the company and investors should find out the key reason for such huge swing.

Of course it is normal for a company to report a negative net cash flow for a couple of financial years due to aggressive business expansion and it is a common industry practice for business to take on more leverages to fund revenue generation.

However, investors must track carefully that the management do not bite off more than it can chew. Normally, I always look at the last five years’ track record of the company and examine whether the company is using the cash to gain market share or acquire other companies that are not aligned to its core competencies.

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