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Is your favourite company burning cash?

Mar 26, 2012

It is common for retail investors to focus more on balance sheets and profit and loss statements. More often than not, they tend to ignore cash flow statements. The reason for the same could be the complexity in understanding and interpreting the latter.

While we have already written a full-fledged article dedicated towards making our readers understand the basics of cash flow statements, we shall touch upon the basics briefly once again.

In simple terms, a cash flow statement indicates how (and how much of) cash has left or entered a company during a particular time period. It helps the investor assess the ability of a company to generate cash.

Broadly, there are three ways a company can generate and use its cash. In fact, this is how a cash flow statement is arranged. The first and most obvious way a company can earn money (or even lose) is through its core business operations. The second way is through borrowing and repaying loans or by raising capital. The third way is by selling or purchasing assets and investments.

But for this article we will focus on one aspect, which is to gauge a company's ability to generate or burn cash in its operations.

A common trend followed by managements of many companies is to boast about their respective company's growth rates. This can especially be seen in annual reports wherein a lot of importance is given to aspects such as sales growth, profit growth or EPS (Earnings per Share) growth. One has to realize the business of a company is to generate both sales and profits. However, at the end of the day it is important from a shareholder point of view that these figures translate into cash generate for the company!

While a shareholder must be concerned over figures such as sales and profit numbers, he should also give importance to the quality of earnings. There are many such aspects that need to be gauged. But the one aspect we will focus on is to look at the cash flow index.

If earnings have been increasing but cash from operations has been declining or turning negative, then it means that the company is just reporting higher income. But in reality its operations are actually burning cash.

The cash flow index is calculated by dividing the operating cash flow (cash from operations) by net profits. If this ratio consistently remains well below 1, then it could be an indicator of potential problems.

Now that you have grasped the idea behind this concept, let us look at the top five and worst five performers in this regard, amongst stocks forming part of the <>BSE-100 Index. It must be noted that we have ignored banking and financial institutions for this calculation.

Top 5 cash burners
Company OCF/ PAT*
Reliance Power Ltd. -47.5
Unitech Ltd. -10.5
DLF Ltd. -7.1
Suzlon Energy Ltd. -6
GMR Infrastructure Ltd. -6

Top 5 cash generators
Company OCF/ PAT*
Essar Oil Ltd. 5.6
JSW Steel Ltd. 4.6
Power Grid Corpn. Of India Ltd. 3.2
Idea Cellular Ltd. 3.2
Hindustan Petroleum Corporation Ltd. 3
Data Source: ACE Equity; *average of the past five years;
OCF stands for Operating Cash Flow

We have taken the average of the past five years. Also, we have only taken standalone figures as it would make the comparison more meaningful.

Devanshu Sampat

Devanshu Sampat (Research Analyst) has a degree in commerce and nearly 5 years of experience in equity research. He draws inspiration from successful value investors across the globe and constantly endeavours to refine his own unique stock picking approach. While a firm advocate of the principles of value investing, he believes in adapting a versatile investing strategy in response to varying market conditions. Devanshu contributes to our Megatrend investing service The India Letter.

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