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Cash flow is the lifeblood of any business. It's the money that comes in and goes out, and it's essential for keeping the doors open and growing the company.
When a company has negative cash flow, it means that it's spending more money than it's taking in. This is a red flag for investors, and it's a good reason to avoid investing in that company.
There are two main types of cash flow that investors should be concerned about:
Operating cash flow (OCF) is the cash that a company generates from its core operations. It's calculated by subtracting operating expenses from revenue.
Free cash flow (FCF) is the cash that a company has left over after paying for all of its operating expenses and capital expenditures (CAPEX). CAPEX is the money that a company spends on new assets, such as equipment and facilities.
Why you should avoid investing in companies with negative cash flows:
There are several reasons why investors should avoid investing in companies with negative cash flows:
Higher risk of bankruptcy: Companies with negative cash flows are at a higher risk of bankruptcy, as they may not be able to generate enough cash to meet their obligations.
Reduced financial flexibility: Companies with negative cash flows have less cash on hand to cover their expenses, which can make it difficult for them to invest in new growth opportunities or weather unexpected downturns.
Burning through cash reserves: A company with negative FCF is not generating enough cash to cover its costs and investments. This means that the company is losing money, and it may be forced to raise additional capital or borrow money to stay afloat.
Investing in unprofitable projects: A company may have negative FCF if it is investing heavily in new projects or expanding into new markets. While these investments may eventually pay off, there is a risk that they may not be successful.
Financial trouble: A company with negative FCF may be struggling to remain profitable. If the company is unable to turn around its business, it may be at risk of bankruptcy.
Fortinet: An example of a company with positive and growing cash flows:
Fortinet is a cybersecurity company that has been generating positive and growing cash flows for many years.
In 2022, Fortinet's OCF was $1.7 billion, and its FCF was $1.45 billion.
This means that Fortinet is generating enough cash from its operations to cover its expenses and investments, and it is also generating additional cash that it can use to grow the business or return to shareholders.
How to find companies' operating & free cash flow figures:
Investors can find companies' operating and free cash flow figures on financial websites such as Macrotrends, Yahoo Finance, and Morningstar.
Investors can also use AI-powered chatbots such as Google Bard and Bing Chat (in More Precise mode) to find this information. However, it is important to double-check the figures to ensure that they are accurate.
The best way to do this is to look at the cash flow statements from the companies' latest earnings reports.
Investors should generally avoid investing in companies with negative cash flows.
Companies with negative cash flows are at a higher risk of bankruptcy and have reduced financial flexibility.
They may also be burning through cash reserves, investing in unprofitable projects, or be in financial trouble.
Investors should instead focus on investing in companies with positive and growing cash flows instead.
Additional tips for investors:
When evaluating a company's cash flow, it is important to look at the trend over time. A company may have a negative cash flow in a single quarter, but this is not necessarily a cause for concern. However, if a company has been generating negative cash flows for several quarters or years, this is a red flag.
Investors should also look at the company's balance sheet to understand its overall financial health. A company with a strong balance sheet will have more cash on hand and less debt, which will give it more flexibility to weather unexpected challenges.