Calculate Cash FlowUnderstanding the Importance of Cash FlowHow to calculate cash flow when assessing bankruptcy risk before you buy penny stocks. Cash flow calculation applied to penny stock companies.
Bankruptcy RiskBankruptcy risk is a measure of the likelihood of a company failing to meet its financial obligations.If a company should fail to bring in enough cash to cover its operating expenses and debt payments, its insolvency risk increases. If this situation continues for long, the company will fold. Bankruptcy risk is the primary risk you must guard against when investing in penny stocks. If a company becomes insolvent while you are holding its stock, you will most likely lose your entire investment in those shares. This is not to be taken lightly. Consequently, most penny stock research centers around assessing bankruptcy risk.
What is Cash Flow?Cash flow is the amount of cash a business keeps after it pays its expenses for a specified period of time.Penny stock companies usually generate cash not from their business operations but from financing, or investments.
Statement of Cash FlowPublicly traded companies file financial statements with the Securities Exchange Commission.These financial reports are all available to the public for free online. One of the financial statements that publicly traded companies file is a cash flow statement. Examining a company's statement of cash flow can help a penny stock trader to understand how safe or risky a particular penny stock trade will be. When looking at financial statements you will often come across the term EBITDA. This means Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a common way that businesses measure cash flow.
Cash Flow Statement PurposeAs a penny stock trader, you will calculate cash flow using cash flow statements to determine whether a company is likely to remain solvent for the duration of the trade before investing in its stock.Buy penny stocks with positive cash flows and enough cash on hand to keep them afloat until you can close out your position. Let past history guide you in this. Look at the past several quarters. How much cash did they use? The answer to this question will tell you if they've got enough free cash flows to get them through the current quarter.
How to Calculate Cash FlowYou can do this if you really want to. Scroll back up to my definition of EBITDA. Assemble all this information for the company you are researching. Now do the math.I personally have never done this. It just isn't necessary. EBITDA is a cash flow calculation. I just use the figures supplied in the company reports. All you want to know when evaluating penny stock companies is do they have a positive or negative cash flow? In other words, is there more money coming in than going out or vice versa? And, do they have enough cash to keep them going until they report again?
Importance of Cash FlowFree cash flow is the best measure of the safety of a penny stock investment.Cash is to penny stock companies what gas is to your car. They can't run without it. Cash can be used not only to pay current operating expenses but to pay down debt. Also, cash rich companies are often takeover targets. This is almost always an advantage to you as a stock market trader. When I advise you to calculate cash flow, I'm urging you to assess the short-term solvency of a company before purchasing its stock.
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