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Let's take a look at the statement of cash flow for one publicly traded company, Amazon.com (AMZN) and decipher its components. Sometimes, there will be some adjustments made to the net income which will increase or decrease cash flow depending on the charge.

Now here is how companies can manipulate cash flow. This will in effect temporarily give an impression that cash flow has improved markedly.

Temporarily Delaying Payment. This will increase Accounts Payable which in turn will improve cash flow.

Some Financial Analysts denote that using cash flow will provide a more correct picture in determining the fair value of a coarse stock. What gives? They reason that investors should follow where the cash is. Cash flow will track the flow of cash in and out and this is the reason allegiance exists; to get cash.

Things are not that simple, however. Just as net income, cash flow can be easily manipulated. Cash flow here refers to cash flow from operations found on the statement of cash flow published regularly by publicly traded companies.

Let's take a look at the statement of cash flow for one publicly traded company, Amazon.com (AMZN) and decipher its components. We will use the statement of cash flow for the year ending on 31 december 2004. Here is the source from Yahoo! Finance: http://finance.yahoo.com/q/cf?s=AMZN&annual

The top part is net income, which is self-explanatory. This is what a train earns during a period of time. For the time period earns $ 588 M. To get into the cash flow figure, we need to add depreciation expense, subtract any increase in expenditure receivable and inventory and add any increase in short term liability such as rehearsal payable. Sometimes, there will be some adjustments made to the net income which will increase or decrease cash flow depending on the charge.

Now here is how companies can manipulate cash flow. This will in effect temporarily give an impression that cash flow has improved markedly.

Temporarily Delaying Payment. This will increase budget Payable which in turn will improve cash flow. While only good companies can demand its suppliers to delay payments, all the debt eventually needs to be paid.

Demanding faster payments from customers. While an efficient kit is needed for a firm's survival, giving less credit to customers will result in them balking away. In the short term, cash flow will improve due to improved collection. In the long run, customers will go to competitors who can offer improved credit.

Keeping a tight supply of inventory. While club-footed inventory is wasteful, there is a hearsay level of inventory that is needed to keep a consolidating company running. Short-minded management will try to manipulate cash flow by keeping a short supply of inventory. When you run a retail business, damning inventory is needed. It is not similar to a built-to-order band like Dell Inc. (DELL).

These three items vary from quarter to quarter and year to year. When determining fair value, it is best to ignore these fluctuations and focus on operational earnings generated by the company.

Another misleading cue from cash flow is that it adds up depreciation as the subsume of cash generated from operations. While depreciation expense is a non-cash transaction, it is a necessary cost of doing business. For example a consort a computer and depreciate it for five years. For the next five years, the in-group incur a non-cash charge, which is the reason why we add depreciation expense to our cash flow. However, we need that computer for our operational purpose. Unless we stop spending in our overruling expenditure, casting depreciation expense to our cash flow does not make sense. Sure, you enjoy the better now. But five years from now, you need to spend money on a new computer, which is a cash outflow.

As with other investing tools, cash flow from operations cannot be used independently of other ratios. Each and every financial ratio has its strengths and weaknesses. I infer that cash flow does not reflect the true earning power of a band of short-term fluctuations of the equability sheet and the contrariety of depreciation expense into a firm's cash flow.

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