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Cash Flow from Operations

Cash flow before any investment or financing activities. If a company cannot generate adequate operating cash flow, it may need to rely on outside funding to meet its financial obligations.

Cash flow from operations is the cash version of net income. Net income figures include non cash costs such as depreciation and excludes other cash expenditures, such as purchases of plants or equipment.

Cash flow adjusts the income figures to a cash basis. Cash flow from operations is cash flow after adjusting for operating differences such as depreciation, but before adjusting for investments (such as purchases of plants or equipment) or financing. This information is taken directly from the cash-flow statement of the company's most-recent annual report.

Example: A media company posts net income of only $73 million. Its cash flow from operations, on the other hand, is $1.4 billion. (The reason: Big depreciation and amortization charges weigh down net income, but since they really aren't cash outlays, these changes have no effect on cash flow.) The company is a much healthier company than its net income would lead you to believe.

Many investors focus on cash flow from operations instead of net income because there's less room for management to manipulate, or accounting rules to distort, cash flow.

If net income is much larger than cash flow from operations, it's a signal that the company's earnings quality-the usefulness of earnings-is questionable.

If cash flow from operations exceeds net income, on the other hand, the company may be much healthier than its net income suggests. That's why many investors, when they try to value a stock, will use the price/cash-flow ratio the share price divided by cash flow from operations per share-instead of the P/E ratio.

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