Cash Flow



1. If you suddenly became unable to work, how much cash would you have coming in (not counting government programs)?

2. How stable is your cash flow?

3. How predictable is your cash flow?

4. How much control do you have over your cash flow?


In the world of business and commerce, value and/or worth will always boil down to cash flow. Ford Motor Company (NYSE: F) had Total Assets amounting to over USD194 Billion as at December 31, 2009 while The Coca Cola Company (NYSE: KO) had Total Assets under USD49 Billion as of the same date. On the other hand, Ford’s market capitalization as at October 18, 2010 was under USD48 Billion while Coca Cola’s was over USD138 Billion. Why the disparity in assets compared to valuation? The answer is found in the Net Operating Income – Coca Cola had over USD6.8 Billion for the fiscal year ended December 2009 while Ford (after multi billion dollar losses in the 2 preceding fiscal years) showed a profit of USD2.717 Billion.

So, Ford’s market capitalization was 17.57 times its net operating income while Coke’s was 20.31 times – the higher valuation multiple for Coca Cola reflects the underlying fact that it was profitable in the preceding 2 years as well as the market’s expectation that it is more likely than not going to remain profitable. Note further that Coke was 2.5 times as profitable as Ford which translated into its being worth 2.875 times (based on the higher reliability of its profits) as much as Ford even though Ford’s Total Assets was 3.96 times as much as Coke’s. It’s not about assets – it’s about cash flow. That’s why some cell phone companies like contracts and landlords like long-term leases (rentals) – the cash flow becomes predictable (within certain limits) for the duration of the underlying agreement. Furthermore, those agreements, (under normal circumstances) make the asset (cell phone company, commercial and/or rental building or equipment) more valuable than if there were no agreements in place (e.g. month to month rental).

Why do we bother to bore you with the foregoing? It is to underscore the importance of cash flow in business valuations. The only fundamental source of enduring value in any asset is the cash flow it can be reasonably expected to generate in the near future.

A typical middle class Joe and/or Jane would likely take comfort in the fact that their personal residence which was purchased for USD150,000 ten years ago is now worth USD225,000 – that can be a type of fool’s gold in the sense that the USD225,000 is what it can be sold for today. Is Jane and/or Joe planning to sell today? Probably not – so, that number is irrelevant. Even if they sell today, would they be needing to redirect the proceeds (less any taxes and costs) to the purchase of a substitute personal residence? Probably – so, once again, the price is irrelevant. The same thing goes for the valuation of publicly traded stocks, bonds and other paper assets – it is based on today’s price. So, when Jane retires in the next 20 years, there is no guarantee  that the price wouldn’t be less than half what it is today – if in doubt, ask any retiree what the last 3 years have meant to their cash flow situations (especially, if they have had to sell some paper assets in that period).

Cash flow is king.

If you have read our page on Personal Equity, you would begin to appreciate why the middle class needs to focus on the goose laying the golden eggs instead of the golden eggs, the gold mine instead of the gold bars, or the oil well instead of crude oil barrels. If you own the mine or the well, you have an enduring source of cash flow that would probably outlive you and pass on to your heirs – that is the purpose of the MCWB Club (if you haven’t joined, you should endeavor to join today).

By focusing on certificates and trade certifications, the middle class has a tendency to get welded to jobs, salaries, wages and fees – there is nothing wrong with this approach. But to become free from the oppression of the minority (the wealthy few), it is necessary to see jobs (along with the accompanying wages, salaries and/or fees) as a means to an end. The end should be to build sufficient personal equity based on predictable upwardly mobile (ever increasing) cash flow.

If anyone tells you to invest for capital gains, be very wary and alert. There should be a place for capital gains in your overall financial structure but you should not count on it (so, be sure to prevent it from becoming a material part of your plan) – furthermore, if and when you commit your funds for capital gains, you should be focused on realizing the gains (cashing out) as soon as possible (think 12 – 24 months). If you think there is still some money left to be made (capital gains wise) in a particular project, cash out enough to return your principal to you plus a sufficient risk return for the length of time you had it out (i.e. time value of money) – in that way, the returns on whatever you have left in the project should not materially affect you one way or the other.

On the other hand, if you have invested for cash flow (for example, in a blue-chip dividend paying stock with a solid track record of increasing dividends), you should consider staying invested forever unless the fundamentals of the business deteriorate materially in a way that threatens the sustainability of the dividend stream and/or the management of the entity changes its philosophy in a way that undermines your interests as a stakeholder. To underscore this, consider this chart for Procter & Gamble (NYSE: PG). Over a 5 year period, it has traded within a fairly narrow band but its quarterly dividend has gone from USD0.28 per share to USD0.482 per share over the same period; even during the market meltdown of early 2009, it did not go below USD46 per share compared to its market highof USD 74.25 per share during the 5 years under consideration. Contrast that with another (non-dividend paying) corporation, Apple Inc. (NYSE: AAPL) whose chart shows a low within the period of USD50.67 per share and a high of USD318 per share. Also, during the meltdown of early 2009, the shares fell from its high (within the period prior to March 2009) of USD199.83 per share to as low as USD82.33 per share. The 5 year period in question for both companies at the time of this writing was mid-October 2005 ~ mid-October 2010.

In conventional terms, Apple is a good stock for capital gains purposes – as long as you buy at the right time and sell at the right time – while Procter & Gamble  (P&G) is a good dividend paying stock. If someone from the wealthy few group was given only these 2 choices, they are likely to put at least 80% of their money  in P&G and not more than 20% in Apple; furthermore, they are going to build all sorts of hedges around the Apple commitment to minimize losses arising from volatility as well as to possibly profit from the volatility. Why is this important? So that you wouldn’t allow any financial planner to console you that the stock market has historically gained 8% per year on average and your capital gains are yet to come. Capital gains are very slippery – they exist but you have to be very nimble and alert to hold them in your hand; cash flow on the other hand is easier to follow and track. When and where possible, learn to follow the money (cash flow) – you’re less likely to go wrong with such an approach.

Finally, the existence of cash flow makes it possible to ask a very important question – one you should never fail to ask anytime your money is on the line  – “How much am I putting in and how soon will I get it back?”. For P&G as at October 18, 2010 you could have bought a share paying USD1.93 per year dividend for USD63.35 implying it would take 32.82 years if dividends stayed the same. A deeper examination shows that the company increases its dividend by an average of 10% each year – when you calculate the payback based on that number, it drops down to 16 years (not including the effect of taxes). For Apple though, the answer is maybe never – if you bought shares on October 18, 2010 at USD318 per share, what guarantees do you have that you would be able to sell it down the line at a price that returns a meaningful profit for the time value of money? None. What guarantees do you have that your mutual fund manager (for those who buy mutual funds – especially for retirement savings) would be skimming off 1% – 2% (management fee) every year regardless? An iron-clad guarantee that you can take to the bank.

In the final analysis, cash flow is king. Always follow the money. It is not enough for the folks managing your money to retain the earnings – not unless they prove to you, based on a solid track record, that they will earn a return that exceeds your other options.

Furthermore, it is not how much you earn that matters but what you do with it and how much you get to keep at the end of the day.There are folks earning USD500,000 per annum today who are going to be worse off than those earning USD60,000 per annum when their financial situations are compared in the next 20 years. Why? Because the lower earning folks would have focused on building their personal equity as a foundation for enduring wealth while the higher earning folks would have consumed their earnings (fancy cars, homes, vacations at exotic foreign locations, clothing and so on). The beauty of building personal equity is that you put the power of compounding at your disposal.

Every unit of currency (money) that passes through your hands and/or bank account has in it the seed of a fortune. Like farmers, middle class folks have to strike a balance between consumption and planting – if a farmer consumes all the harvest, there is no seed for the next season and the farm may have to be shut down and/or sold. Similarly, if middle class folks spend all their earnings on consumption (non-cash generating/replenishing goods and services), they are at the mercy of their employers and when employers know that they have leverage, they will try to force down wages (just keeping wages the same or increasing them below the inflation rate is a lowering of wages in real terms). The worst thing middle class folks can do in these days of high unemployment and increasing employer leverage to force wages and benefits down is to not make provision for building up personal equity. There is also a need for the middle class to get smarter about taxes (more about that on our Taxation page).

Remember that, for lending decisions, bankers are only interested in the historical, current and projected future cash flow – not the value of the asset. Yes, for residential mortgages, they would take the appraised value of the building into consideration as a fall back position – their primary focus for expected repayment is the underlying cash flow (of the asset and/or borrower). Should you propose that primary repayment is a sale of the asset, they would lend only 10% – 40% of the appraised value compared to the 60% – 75% they would ordinarily lend when primary repayment is based on cash flow. Learn from them – they may not have the best interests of the middle class in mind, but they at least know how to get their loaned funds back (many in the middle class fare poorly on that score – ask the victims of the recent [or any] market meltdown).

Finally, as you live below (not at, or above) your means while expanding those means, remember that cash flow is king. It is good to periodically study your personal budget to see where the cash goes out and where it comes in. If you have only one source of (incoming) cash – probably a job, trade or profession -, it is time to start building Personal Equity to reduce your dependence on that single source as well as increase your sense of control over the unknown while concurrently reducing your vulnerability to unexpected outside shocks. The MCWB Club’s sole purpose is to help middle class folks build wealth (based on predictable cash flow) as fast and tax-efficiently as possible and no efforts will be spared to protect your interests – take advantage of the existing deep discount coupons to join today (if you have joined, consider telling a friend, colleague or family member using the Tell A Friend tool at the bottom of this page).