If some one want to draw a clear picture of a company that what it is doing in a specific period of time e.g. during a quarter or during a financial year. He may use the cash flow as measuring tool, as if you want to learn the exact amount of cash that a company brings in and use it during any specific accounting period without addressing all its fixed expenditures, you will use cash flow as a tool because cash flow does the same which you are looking for.
In the stock markets cash flow is a good measuring tool for investors who want to understand the exact performance of a company in a given accounting period
As cash flow is an earning before deductions like interest, taxes, depreciation and amortization. In the next paragraph I will highlight the role of deductions.
As a matter of fact each company generates positive or negative cash flow during its operations, so when you apply these four deductions I mean Interests, taxes, depreciation and amortization you distort cash flow generated by company during its operation. As all these four deductions have noting to do with companies actual operations these are just accounting conventions which reduces income for tax purposes.
Companies normally deduct the interest payments from their income for tax purposes. And the amount of this deduction is variable and it changes each year.
Tax is another deduction which is also not a fix deduction it may change according to laws of the land changes, resulting a shrink in net income too.
Depreciation is applied on assists according to the tax code and companies apply the code to deduct a portion of amount from their assets. The deduction schedule is pre determined. And when Appling the schedule creation professional formalities are observed to keep the schedule coincide with the useful life of the particular asset
Amortization is almost like depreciation but it differs from depreciation when company pay a premium, payment of premium is goodwill and company will amortize the cost.
Remember both depreciation and amortization are non cash deductions they do not involve any cash however the reduce the companies net income in the books. In the case when companies invest heavily in buildings and real estate the deduction of depreciation become more prominent and on the books the do not show significant growth or income.
An investor can use cash flow efficiently as a measuring tool for this a comparison is required with the similar companies and with the market as a whole.
Now a day many web sites offer the facility of calculations for investor all you have to do is to place a symbol of the company on the particular place and with a few clicks of mouse you will be able to reach on a page where comparison is available and you will find the cash flow ratio. However the navigation method may vary fro each such site.
