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Most of our readers would understand the importance of cash flows from operations. They indicate that a company is able to generate cash from its sales. If a company's profits are not backed by sound cash flows from operations, that is a potential red flag.
Another useful concept is that of free cash flows (FCF). This is the cash remaining after satisfying the company's operational needs and capital expenditure. A company that generates high free cash flow has a superior standing. Free cash flow has two variants: free cash flow to the firm (FCFF) and free cash flow to equity (FCFE). While FCFF takes into account cash flows available to both shareholders and debt holders, FCFE takes into account only cash flows available to shareholders.
Since free cash flow is not a standardised metric, it is not provided readily and has to be separately calculated. Also, current SEBI regulations require cash-flow statements to be provided only twice a year. Also, it doesn't take into account the possibility of contingent liabilities materialising.
Case in point: VST Industries
Between FY17 and FY21, the profit after tax of VST Industries doubled from Rs 152 crore to Rs 311 crore. But free cash flows more than doubled from Rs 119 crore to Rs 281 crore. This was, in no small part, attributable to the low amounts of reinvestment needs of VST and it is not surprising that dividends were also continuously increased in this period.
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