What is Cash Flow Per Share (CFPS)?
Cash flow per share is a profitability measure that allocates the amount of firms’ cash flows to each share of common stock. Experienced investors and professional market analysts consider this to be a better profitability metric than the popular earnings per share (EPS).
How to Calculate Cash Flow Per Share?
Cash flow per share can be calculated as a ratio that divides the cash flows generated under normal business operations after adjusting for preferred dividends during a reporting period (yearly, semi-annually or quarterly) by the total number of shares outstanding or the weighted average number of shares. A weighted average number is generally used because the number of common outstanding shares can fluctuate over the given period.
It can also be calculated using net income or EBIT (earnings before interest and taxes) by adding back the cost of depreciation and amortization to EBIT which are non-cash transactions and do not involve in actual cash flows from operations by any outflow.
Cash Flow Per Share Examples
Let’s see some simple examples of Cash flow per share.
Mr. Unknown of Ethical analytics has to calculate the Cash Flow Per Share (CFPS) of Hypothetical Pvt. Ltd using the following data extracted from the financial statements of the company:-
Calculation of Weighted Average Number of Shares
For 2018 8-lakh shares for a full year and 2-lakh shares for a half year
=8+2*6/12 =9 Lakh
For 2019 10-lakh shares for the full year
Therefore, Calculation of CFPS for 2019 is-
Similarly, we have done the calculation of CFPS for 2018
Ethical analytics again tasked Mr. Unknown to calculate the Cash Flow Per Share (CFPS) of another company XYZ Pvt. Ltd. But this time data from cash flows statements are not available but are available from the income statement as given below:-
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Calculate CFPS for 2019 using below formula of Cash flow per share,
- Cash Flow per Share Formula = (EBIT * (1 – tax rate) + Depreciation) / Common Shares Outstanding
Similarly, we have done the calculation of CFPS for 2018
- Cash Flow per Share = (100*(1-30%)+20)/9
Why Cash Flow Per Share is Better than EPS?
EPS or Earnings per Share is the most popular profitability metric used by investors and analysts to measure the number of profits allocated to its equity (common) shareholders. It is calculated by dividing the company’s net income or EAES (earnings available to equity shareholders) by the weighted average number of shares outstanding.
EBIT or net income is calculated after the company generates revenues (sales). Many times sales are made on credit i.e. zero cash inflow but it increases the earnings of the company. Also, EBIT is calculated after deducting the cost of depreciation and amortization (non-cash expenses) and further net income will be calculated after subtracting various non-recurring and irregular expenses.
All these factors can deflate the value of net income artificially. Also, EPS can be easily manipulated through liberal accounting practices.
This example will try to justify the popular quote about cash flows: “Cash is the King”.
Kingsman Pvt. Ltd has an innovative product with low production cost and expected high demands. With high enthusiasm, they invest heavily in setting up a production line, building warehouses and market their product. The company issued 100,000 equity shares at the rate of 10 per share to meet all of its expenses.
The demand was high as expected but the new players generated most of their sales on credit. And due to the low cost of depreciation, the profit (net income) figure appears huge in the beginning. But later the company starts lacking availability of cash in hands. The company now has to lower its production capacity, cut its costs or has to apply for some loan which further has costs.
The company’s income statement for the first quarter is as follows:-
EPS = Net Profit / Number of shares outstanding = 490 / 100 = 4.9
The Net Profit values are huge and the EPS ratio is quite good but then also a crisis for cash arrives at the company.
The management of the company must have checked the cash flow statements and calculated more reliable profitability ratio of CFPS.
Operating Cash Flow = Operating Cash Inflow – Operating Cash Outflow
= 500 – (280+210) = 10
So the calculation of CFPS is as follows,
cash flow per share formula = Operating Cash Flow / No. of shares outstanding
= 10 / 100
The Kingsman if tracked its cash flows earlier, it would have known its poor cash collection performance and would have avoided the situation of crisis. High EPS just indicates the expected earnings the shareholders may get in the form of dividend for every share they held. CFPS shows the actual cash flow carried by the Kingsman during the quarter.
- EPS is an important profitability metric but CFPS should never be overlooked.
- Earnings can be manipulated but cash flows present the true picture. Hence in finance and accounting, it is said that “Cash is the King”
- Every company to a certain extent manipulates some numbers to increase or decrease their profit values. E.g. services to be provided over the next three years, the company recorded a lump-sum amount of all three years as revenue in the current year itself and inflate the overall value. a company should have distributed the revenue in all three years or record as and when received
- Companies show assets worth billions in their books but actually did not exist ever and charges heavy depreciation to lower their profit figures in order to pay fewer taxes. Classic examples are companies like Enron, Worldcom, Adelphia. Their Balance sheet looks extremely impressive and justifies the low-profit figures due to high depreciation costs. Such extreme manipulation enters the category of frauds.
- Investors must also study cash flow statements and calculate financial ratios like CFPS other than EPS or P/E ratio.
This has been a guide to Cash Flow Per Share and its definition. Here we discuss how to calculate Cash Flow Per Share along with practical examples. We also discuss the difference between CFPS vs EPS. You can learn more about accounting from following articles –