September 21, 2023

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Look In The Business

Why do people prefer cash flow per share over earnings per share?

Cash Flow Per Share

How does one measure the financial strength of a firm? There are many ways to have an idea, but today, we will talk about one measure, and it is called cash flow per share. It’s the after-tax earnings with the depreciation on a per-share basis. When we read news about companies and how they are doing, we look for the comments and opinions of analysts. On the way, you may have encountered the term EPS or earnings per share as well. They also mention this EPS, but they stress more on the cash flow per share because, unlike EPS, it cannot be easily manipulated and altered. Hence, you will have a clearer picture of the strength and sustainability of a specific business model.

What is a cash flow per share?

How can we calculate cash flow per share? It is done as a ratio while indicating the cash amount the business makes depending on the company’s net income, the costs of depreciation, and the added amortization. But if we think about it, amortization and depreciation are not cash expenses. So, adding those makes the company’s cash flow numbers prevent artificial deflation. Here is the formula that we can use to get the cash flow per share:

Cash flow per share= (Operating cash flow – Preferred dividends)/ Outstanding common shares

But what is free cash flow?

Have you heard of the term free cash flow? If you did, maybe it is because it’s similar to cash flow per share. It expands when it tries to avoid company cash flow deflation. If we calculate it, we consider the costs involving one-time capital expenditures, dividend payments, and non-recurring or unusual activities. The company also needs to consider these expenses as they happen instead of spreading them out in the long run. Free cash flow gives us a clearer picture of the cash amount that a company makes in the examined period. Investors will most likely opt to evaluate free cash flow per share rather than EPS because it is more accurate in showcasing a company’s financial and profitability status.

Earnings per share seem like the second-best.

We have been mentioning EPS or earnings per share. But what is it about? It is a part of the profit allocated to every common stock outstanding share. It is similar to cash flow per share because it can also give one an idea about a company’s profitability. However, many investors and analysts prefer using cash flow per share because it is less accurate. One can calculate it by getting the company’s profit or net income and dividing that by the outstanding shares.

Now, we have mentioned that it is less accurate. Why? Unlike cash flow per share, it does not consider amortization, depreciation, unusual expenses, and the like. In this case, the EPS calculation tends to be artificially deflated since these things we just enumerated are subtracted and not considered. On the other hand, EPS can also be artificially inflated using income sources aside from cash like goods and services on credit issued through the selling company. Aside from that, we can also include the appreciation of the investments.

Some thoughts to ponder

Cash flow per share considers the company’s capability to make money. Hence, many people say that it is a more accurate measure of a company’s financial status. Cash flow per share stands as the net cash that a firm generates on a per-share basis.