What Is Cash Flow Per Share?
Cash flow per share is a financial metric that indicates the amount of cash generated by a company for each outstanding share of its common stock. It is a type of financial ratio derived from a company's cash flow statement, a core component of its financial statements. This metric falls under the broader category of financial analysis and is often used by investors and analysts to assess a company's ability to generate liquid funds from its operations, independent of non-cash accounting entries. Unlike traditional earnings, cash flow per share focuses on the actual cash a business produces, providing a different perspective on its financial health and operational efficiency.
History and Origin
The concept of evaluating a company's cash generation has evolved significantly over time. While the balance sheet and income statement have long been standard financial reports, the formal requirement for a cash flow statement in the United States came relatively recently. Early forms of cash transaction summaries appeared as far back as 1863, with companies like Northern Central Railroad providing outlines of cash receipts and disbursements10. Initially, many companies focused on changes in "funds," often defined as working capital (current assets minus current liabilities)9.
However, dissatisfaction with the inconsistent definitions of "funds" and a desire for more transparent financial reporting led to changes. The Financial Accounting Standards Board (FASB) played a pivotal role in standardizing cash flow reporting. In 1987, FASB Statement No. 95 (SFAS 95), now incorporated into Accounting Standards Codification (ASC) Topic 230, "Statement of Cash Flows," mandated that U.S. firms include a cash flow statement in their financial reports8. The Securities and Exchange Commission (SEC) also plays a critical role in mandating and regulating the transparency of financial statements for public companies, ensuring investors have access to crucial financial data7. While the cash flow statement became mandatory, the FASB specifically prohibited the reporting of "cash flow per share" in financial statements to avoid confusion with earnings per share6. Despite this prohibition in official reporting, analysts and investors commonly calculate cash flow per share as a supplementary analytical tool.
Key Takeaways
- Cash flow per share measures a company's cash-generating ability on a per-share basis, focusing on actual cash movements rather than accounting profits.
- It is calculated by dividing total cash flow (often operating cash flow) by the number of outstanding common shares.
- This metric provides insights into a company's liquidity, solvency, and ability to fund operations, investments, and dividends.
- Unlike net income, cash flow per share is less susceptible to accounting manipulations or non-cash charges like depreciation.
- While a useful analytical tool, cash flow per share is not a GAAP-recognized metric and should be used in conjunction with other financial indicators for comprehensive valuation.
Formula and Calculation
The most common approach to calculating cash flow per share involves using cash flow from operating activities, as this reflects the cash generated from a company's core business.
The formula is as follows:
- Cash Flow from Operating Activities: This figure is found on a company's cash flow statement and represents the cash generated or used by the company's normal business operations. It is often considered the most reliable measure of a company's ability to generate cash internally.
- Number of Outstanding Common Shares: This represents the total number of a company's shares held by investors, including restricted shares owned by company officers and insiders, as well as those publicly traded.
Interpreting the Cash Flow Per Share
A higher cash flow per share generally indicates a company's strong ability to generate cash from its core operations. This can be a positive sign for investors, as it suggests the company has sufficient funds to cover its expenses, repay debt, invest in new projects (capital expenditures), and potentially distribute dividends to shareholders. When interpreting cash flow per share, it is crucial to consider the company's industry, business model, and growth stage. For example, a rapidly growing company might have lower cash flow per share if it is heavily reinvesting cash into expansion, whereas a mature company might exhibit higher, more consistent cash flow per share. Comparing the metric over several periods and against industry peers provides a more meaningful analysis.
Hypothetical Example
Consider TechInnovate Inc., a hypothetical software company. For the latest fiscal year, TechInnovate reported cash flow from operating activities of $50 million. During the same period, the company had 25 million shares of common stock outstanding.
To calculate TechInnovate's cash flow per share:
This means that for every outstanding share, TechInnovate generated $2.00 in cash from its core business operations. If, in the prior year, TechInnovate's cash flow per share was $1.50, the increase to $2.00 suggests an improvement in the company's ability to generate cash from its operating activities. This insight is valuable alongside other metrics found on the company's financial statements.
Practical Applications
Cash flow per share is a practical analytical tool used in various aspects of financial analysis. Investors often use it to gauge a company's financial strength, particularly its ability to sustain operations and fund growth without excessive reliance on external financing. For instance, companies with consistently high cash flow per share may be seen as more resilient during economic downturns.
In valuation, analysts may use cash flow per share as a component in models such as discounted cash flow (DCF) analysis, where the focus is on the present value of future cash flows. It can also be compared to a company's stock price to derive a price-to-cash flow ratio, which helps assess whether a stock is overvalued or undervalued relative to its cash generation. Warren Buffett, a renowned investor, has emphasized the importance of a company's free cash flow, noting that it provides a more transparent view of profitability than earnings alone, which can sometimes be influenced by accounting treatments5. He often looks for businesses that generate substantial and consistent cash flow from their operating activities over the long term, viewing cash as the true measure of a company's economic performance4.
Limitations and Criticisms
Despite its utility, cash flow per share has notable limitations. A primary criticism is that it is not a recognized metric under Generally Accepted Accounting Principles (GAAP). The Financial Accounting Standards Board (FASB) specifically prohibits the presentation of cash flow per share in official financial statements to prevent confusion and imply that it is a substitute for earnings per share3. This means investors will not find this metric directly reported in a company's annual or quarterly reports but must calculate it themselves.
Furthermore, while cash flow per share provides insight into a company's cash-generating ability from operating activities, it does not account for necessary capital expenditures required to maintain or grow the business. A company might have high operating cash flow but still require significant investment in property, plant, and equipment, reducing the actual cash available to shareholders. Academic research often debates the predictive power of cash flows versus earnings in forecasting future financial performance, with some studies suggesting that accrual-based earnings can offer superior predictability in certain contexts, while others find cash flows to be a better predictor2,1. Therefore, relying solely on cash flow per share, without considering factors like investing activities and financing activities or comparing it with other profitability metrics, can lead to an incomplete or misleading assessment of a company's financial health.
Cash Flow Per Share vs. Earnings Per Share
Cash flow per share and earnings per share (EPS) are both per-share metrics designed to help investors evaluate a company's performance, but they derive from different financial statements and reflect distinct aspects of profitability.
Earnings per share is calculated using a company's net income from the income statement. Net income is an accounting profit that includes non-cash expenses, such as depreciation and amortization, and non-operating gains or losses. EPS is often considered a key indicator of a company's profitability and is a widely reported GAAP metric.
Cash flow per share, on the other hand, is derived from the cash flow statement, specifically focusing on the actual cash generated from operating activities. It excludes non-cash items and provides a clearer picture of a company's liquidity and its ability to fund its operations and investments directly from cash. The core difference lies in their underlying basis: EPS is an accrual-based measure, while cash flow per share is a cash-based measure. This means EPS can be influenced by accounting estimates and judgments, whereas cash flow per share is generally considered more difficult to manipulate, focusing purely on cash inflows and outflows. Investors often use both metrics in conjunction, as EPS shows accounting profitability and cash flow per share shows the financial robustness behind those profits.
FAQs
What does a high cash flow per share indicate?
A high cash flow per share generally indicates that a company is generating a significant amount of cash from its core business operations relative to its outstanding shares. This suggests strong liquidity, operational efficiency, and the ability to fund growth, repay debt, or distribute dividends without needing external financing.
Why is cash flow per share not reported on financial statements?
Cash flow per share is not reported on official financial statements because the Financial Accounting Standards Board (FASB) prohibits its presentation. The FASB aims to prevent confusion and ensure that users do not mistakenly view it as a substitute for earnings per share, which is an accrual-based measure of profitability.
Is cash flow per share more important than earnings per share?
Neither metric is inherently "more important"; rather, they offer different insights. Earnings per share (EPS) reflects a company's accounting profitability, including non-cash items, while cash flow per share shows the actual cash generated from operations, indicating liquidity and financial flexibility. A comprehensive analysis typically involves examining both to get a complete picture of a company's financial health.
How does cash flow per share relate to a company's liquidity?
Cash flow per share directly relates to a company's liquidity because it measures the actual cash generated from its primary business activities. A higher cash flow per share suggests that the company has ample liquid funds to meet its short-term obligations, invest in operations, and navigate economic fluctuations, demonstrating strong financial resilience.