23 June 2011

Why Managing Cash Flow is So Important to Your Investment Process - Part 6

In Business, we have a cash flow statement to show us three major parts:

CFO = Operating Cash Flow
CFI = Investing Cash Flow
CFF = Financing Cash Flow

I will explain one by one in our investment portfolio.

CFO = If you have the business income / salary income / self-employed income / rental income, your net income (earning - expenses) will be put under here. Basically CFO is a measure on how you can survive in long run.

CFI = If you require money to invest in any kind of investment products such as stocks, unit trusts, real estates and other financial assets, then your CFI is outflow. However, if you sell the products and get the capital gains, then the after tax capital gain will be parked under here. Of course your interest income can be park under here too.

CFF = If you are using other's people money, then you are getting CFF. If you are paying others people money, then you are reducing CFF. Basically we can call it Net Borrowing for the CFF in our individual cash flow statement.

From financial analyst's perspective, the most important cash flow measure is Free Cash Flow to Firm (FCFF) and Free Cash Flow to Equity (FCFE). Since we are now discussing about the individual, then we will discuss more in FCFE in detail.

FCFE formula that I adjusted based on individual cash flow statement = CFO (Net Business/Self Employed/Salary Income - Living Expenses) + CFI (Investment Return In Cash - Investment Cash Outflow) + CFF (Net Borrowing).

To get the biggest FCFE, you must optimize the combination of both 3 cash flows here: CFO, CFI and CFF.

To be continue...

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