Cash flow analysis of stocks

              Working capital ratio

Working capital refers to the amount of cash available. This liquidity factor is crucial to the running of a business operation. Cash is needed to pay on going liabilities to make pay roll, to order Merchandizes and, in the long term, to fund expansion. The most popular test of working capital is the current ratio which examines and compare current assets and current liabilities.

        Current asset.     

                                          =working capital ratio

        Current liabilities .   

A general standard for the current ratio is 2:1, which means current assets two fold current liabilities one fold. The real danger occur when the ratio become less than 1. For example: if the current ratio 1 to 2 meaning that there were twice as many current liabilities as current assets, that's would be danger signal.

Working capital is an indicator how well a company manage its money. Plans for timely payment of bills and plan. For long term growth, cash flow is essential oxygen that keeps a company alive. Current ratio is not only test of working capital. 

In corporation with significant level of inventory, the current ratio is often lower than 2 to 1, out of necessity because inventories are offset by higher accounts payable. Because seasonal volume varies widely, it is possible that your end inventory levels will be quite high. In this circumstances, second working capital ratio used it is called quick asset ratio Or acid test ratio.

This is current ratio excluding inventory. The general standard defining a "goods" level for the quick asset ratio is 1 to 1. So, if the quick assets are equal to or higher than the total current liabilities, that is acceptable.

A third test, which evaluates the company's efficiency in handling and maintaining inventory levels, is inventory turn over. The formula for inventory dividing cost of goods sold by the average inventory level.

       

                        Turn over ratiot

Turn over would remain steady even when revenue increases substantially. However, there is a tendency for turn over to slow down with greater volumes.

Finding the average inventory in the annual report can be a potential problem. You may need to look at company's quarterly financial statements in order to determine whether year end inventory is representative for the entire year.

In some corporation, inventory level remain stable, so average can simply require taking the beginning and ending balances and using the average of two.

But other companies experience wide seasonal swings in inventory level and the real average could be more complex. The four quarter - end inventory levels are added together and divided by four to find a more representative  average.

The current ratio has become a prominence and important test. But it can easily mislead you, if you are not always of aware of how capitalization trends work. Capitalization is simply the funding of a company. It comes from two general sources equity is provided by investors who expect dividends and stock appreciation. Debt comes from lenders who expect periodic interest and repayment of loan.

                         Long term debt

Many investors are not fully aware of how the long term value of the stock and the continuation of dividends are threatened when the other type of capitalization increase over time. This debt in the form of long term notes and bonds issued by the corporate can have a negative on long term growth in several ways.

First, the higher amount of debt the higher the future debt service or repayment obligation.

Second, the higher amount of debt is, the greater expenses will be. There is natural competition for operating profits between dividends and interest.

The ratio every one need to understand is called the long term debt to equity ratio. If a company begin accumulating long term debt and keep the proceeds in cash. The current ratio maintained at what appeared to be a healthy level. But only long term debt continues to grow 

A company's sales and revenue is being negative direction, in that situation, it is not possible to maintain the current ratio unless long term debt is increased. The significant shift toward higher debt capitalization mean the features net earnings will be used to pay growing burden of interest rate.
           

                          Cash is king

A company's income statement can show a healthy profit for the year, but this does not guarantee that it has cash necessary to survive. Profit is not cash. Profit is an accounting measure, cash is a physical item. Companies can survive without profit as long as they have cash available. Even a profitable cannot survive without cash. Every activity of company is translated into cash at sometimes companies use it to pay employees, suppliers and customers use it to purchase product and services. It is necessary to allow investment in assets to support growth and pay interests and dividends to providers of financial resources and to pay taxes.

A starting point for assessing the strength of a company's cash position is to look at the changes i n the amount of cash held at the beginning and end of the year. An increase in cash held could be taken to be a good sign representing an improvement in liquidity. 

A company with a shortage of cash may be in trouble. A company with a lot of cash may not be operating as profitably as it could be.

A large figure of cash in annual report, may simply reflect the setting aside of money to pay for machines in the following financial year.