HOW-TO evaluate the state of a company's cash flows?

١٦ يونيو ٢٠٢٣

The other day I came across an interesting article about the work of the Swiss company Glencore International AG in the 1990s. This company specializes in trading raw materials, and at that time it was actively trading with the countries that had left the USSR. None of those countries had foreign currency, and trust in local currencies had not yet appeared, so it was necessary to exchange commodities for commodities like in the Middle Ages. For example, to sell copper from Kazakhstan, a Swiss company bought raw sugar in Brazil, then took it to Ukraine for refining, then the refined sugar was exchanged for Siberian oil in Russia, then the oil was exchanged for copper ore in Mongolia, which was then sent to a plant in Kazakhstan to create copper suitable for sale on the world market. As we can see, money was used here only at the moment of purchase of raw sugar and sale of copper, the rest of the chain of transactions was an exchange of goods for goods. It turns out the following scheme:

Money - Raw sugar - Refined sugar - Oil - Copper ore - Copper - Money'

Of course, all of this made sense when Money' (with a stroke) equaled big money. Otherwise, the cost of preparing and executing such a complex transaction simply wouldn't have paid off.

This example once again convinced me how significant a role money plays in any company's operations. Can you imagine the chaos that a business can become without money and having to make up similar supply chains? Money simplifies and speeds up all processes in a company, so competent management of these flows is the basis of an effective business.

If you compare a company to a living organism, Cash Flow (*) is its circulatory system. It is thanks to this system that the company is supplied with everything it needs to produce goods or services.

(*) If you want to learn more about Cash Flows, I suggest reading my two articles on TradingView:
Cash flow statement or Three great rivers
Cash flow vibrations

Considering that cash flows play a fundamental role in the activity of any company, it is reasonable to assume that their analysis will give us the necessary information to make a decision.

For this reason, an additional parameter was added to the Fundamental Strength Indicator - the dynamics of Cash Flows expressed in Diluted net income (*).
(*) Since the value of income can be negative, the Diluted net income module is taken, that is, without the "minus" sign.

Why do I use income as a unit of measure of Cash Flows? Because it is a good way to make the scale of indicator values the same for companies from different countries, with different currencies. It also allows you to use a single value scale for both Cash Flows and Fundamental Strength.

So, let's take a look at how the dynamics of Cash Flows look like in the Fundamental Strength Indicator. These are three lines of different colors, which are located over the Histogram. Each of the flows corresponds to a specific color:

• Operating cash flow - green line;
  
• Investing cash flow - orange line;
  
• Financing cash flow - red line.
  

In this way, I can track the dynamics of the company's Cash Flow over time.



To interpret the dynamics of Cash Flows, I pay attention to the following patterns:

- How the cash flows are positioned in relation to each other;
- In which zone each of the cash flows is located - in the positive or negative;
- What is the trend of each of the cash flows;
- How volatile each of the cash flows is.

As an example, let's look at several companies in order to interpret the dynamics of their Cash Flows.

John B. Sanfilippo & Son, Inc.


This is the most ideal situation for me: operating cash flow (green line) is above the other cash flows, investment cash flow (orange line) is near zero and practically unchanged, and financial cash flow (red line) is consistently below zero. This picture shows that the company lives off its operating cash flow, does not increase its debt, does not spend a substantial amount of money on expensive purchases, and retains (does not sell off) assets.

Parker Hannifin Corporation


With stable operating cash flow (green line), the company implements investment programs by raising additional funding. This is noticeable due to an increase in financial cash flow (red line) and a simultaneous decrease in investment cash flow (orange line) with a significant deepening into negative areas. Apparently, there is not enough operating cash flow to realize the planned investments. One has to wonder how sustainable a company can be if it invests in its development using borrowed funds.

Schlumberger N. V.


The chaotic intertwining of cash flows outside of the Fundamental Strength range (-15 to 15) is indicative of the company's rich life, but to me, it is an indicator of high riskiness of its actions. And as we can see, Fundamental Strength has only begun to strengthen in the last year, when the external appearance of cash flow has normalized.

Thus, when the Fundamental Strength of two companies is equally good, I use an additional filter in the form of Cash Flow dynamics. This helps me to clarify my interest in this or that company.

Concluding the series of training posts about the Fundamental Strength Indicator, I would like to make general conclusions and talk about the risks.

What is the value of the Fundamental Strength Indicator:

- allows for a quantitative assessment of a company's financial performance in points (from -15 to 15 points);
- allows you to visually track how the company's financial performance has changed (positively/negatively) over time;
- allows to visually trace the movement of main cash flows over time;
- speeds up the process of selecting companies for your shortlist (if you are focused on financial results when selecting companies);
- allows you to protect yourself from investing in companies with weak and mediocre fundamentals.

Mandatory requirements for using the indicator:

- works only on a daily timeframe;
- only applies to shares of public companies;
- company financial statements for the last 4 quarters and more are required;
- it is necessary to have the data from the Balance sheet, Income statement, and Cash flow statement, required for the calculation.

If at least one component required for calculating the Fundamental Strength is missing, the message "no data to calculate the Fundamental Strength correctly" is displayed. In the same case, but for the operating cash flow, the message "no data to calculate the Operating Cash Flow correctly" is shown, and similarly for other flows.



Risk disclaimer:
When working with the Fundamental Strength Indicator and the additional filter in the form of Cash Flows, you should understand that the publication of the Balance sheet, Income statement, and Cash flow statement takes place sometime after the end of the financial quarter. This means that new relevant data for the calculation will only appear after the publication of the new statements. In this regard, there may be a significant change in the values of the Indicator after the publication of new statements. The magnitude of this change will depend both on the content of the new statements and on the number of days between the end of the financial quarter and the publication date of the statements. Until the date of publication of the new statements, the latest relevant data will be used for calculations.

I would like to draw your attention to the fact that the calculation of Fundamental Strength and Cash Flows requires the availability of data for all parameters of the valuation model. It uses data that is exclusively available on TradingView (there is no reconciliation with other sources). If at least one parameter is missing, I switch to another company's analysis to continue using the indicator.

Thus, the Fundamental Strength Indicator and an additional filter in the form of Cash Flows make it possible to evaluate the financial results of the company based on the available data and the methodology I created. A simple visualization in the form of a three-color Histogram, a Blue line, and three thick Cash Flow lines significantly reduces the time for selecting fundamentally strong companies that fit the criteria of the selected model. However, this Indicator and/or its description and/or examples cannot be used as the sole reason for buying or selling stocks or for any other action or inaction related to stocks.