Saturday, June 9, 2012

Value Indicators:  Growth in Cash Flow from Operations

As a bit of background to financial statement analysis, let me share a truth: profit is an accounting construct and cash is king.

I have an accounting background and tremendous respect for its symmetry.  I love the way the transactions get captured and each of the three statements flow into one another.  Its development, without a doubt, was inspired genius.  But it has weaknesses.  A lot of them stem from the rule framework (GAAP) that has developed in the past one hundred years or so.

GAAP offers discretion in certain policy choices that ultimately effect the number that we call "net income" or "profit" or "earnings".  Cash on the other hand is much more independent, much harder to manipulate.  In the Statement of Cash Flows, the movement of cash is separated into three areas: Cash from Operations, Cash from Financing and Cash from Investment.

Growth in cash from operations is indicative of how well the company is managing its operations and creating value.

According to Mr. Graham, we want to see growth of 6 to 7% per year.

To execute this analysis, build an analysis template in Verdant by selecting Cash Flow from Operations Activities for each of Y, Y-1, Y-2, Y-3 etc.

Go back into portfolios and choose US Integrated Oil & Gas.  Click the "Analyze" button and select the appropriate template.  Export to Google.  Once in Google build several growth equations.  We want to see the growth year over year, for example the growth in Y over Y-1.  The equation is


Where F2 is CFO in the current year G2 is CFO in the prior year.

There are different ways to determine the growth of 6 or 7% per year.  For expediency, I just took an average with this equation:

I then wrote two "if" equations.  One to give a rating of 1 if the average was greater than 7%, zero if not and the other to give a rating of -1 if the average was less than zero, zero if otherwise.  Here they are respectively:


Q2 is the average that was calculated above.

The final step is to sum the two ratings to get a final rating:

 That is it for this indicator!  To see the whole spreadsheet click here.

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