Investors cash flow
Many investors use the cash flow of a company as an important indicator. Investors find a company with an increasing cash flow worth investing in. When the company has a negative or declining cash flow, investors will think again about investing in such a company.
A positive cash flow means that the company can continue their current operations in the future. On the other hand, a company that will spend more money than it receives, the company will not be able to pay their bills in the future. So the cash flow determines the continuity of a company.
The cash flow is affected, as the words say, by the flows of cash in and out of the company. Direct flows into the company are for example sales income related to the core business. Other income might be coming from selling property, when the buying party pays directly. Expenditures that influences the cash flow are, amongst others, payments to suppliers, interest payments and dividends payments.
Cash flow for investors
Like for companies, the cash flow is also important for individuals (like investors). Without a positive cash flow, a individual cannot make the ends meet. And just like companies, individuals can have multiple flows of cash. Employees receive money from their employers. Company owners receive money from their property. And investors receive money from their investments. Besides the positive cash flows, an individual also has negative cash flows, like rent or mortgage, and of course food and drinks.
As mentioned, cash flow can come from investments. There are three main sources of positive cash flows that can be received from owning stocks. First, stocks can be sold. Secondly, dividends can be received from stocks. And finally, call options can be written to receive income (and a positive cash flow) from stocks. These three possibilities will be explained in this article.
Cash flow from selling stocks
An investor can get a one time positive cash flow selling stocks that he owns. One advantage is that selling stocks has a direct positive impact on the cash flow. However, there are some disadvantages of this type of cash flow creation.
First of all, the stocks should have been bought by the investor. To have a positive cash flow on the longer term, buying and selling stocks must result in a positive cash flow. This means that the price of the stocks should be higher on the moment of selling compared to the buying price. If not, the long term cash flow from this transaction will be negative.
Another disadvantage is that selling stocks results in a one time cash flow. If the cash is not invested again, it will remain a one time cash flow. If the money will be fully reinvested, the positive and negative influences on the cash flow will balance out. So this will also not cause an impact on the cash flow.
Cash flow from dividends or interest
The cash flow from dividends is another cash flow for investors. Dividends is being paid by a lot of companies. Most of the time it is paid once a year, but more and more companies are spreading the dividend payments over the year. Also bonds are earning a annually (or semi-annually) payment. This is the interest paid on bonds.
The advantage of cash flow from dividends or interest, is that the investment does not need to be sold. The value of the investment remains more or less the same. Besides that, the positive influence on the cash flow will recur annually.
The disadvantage of cash flow from dividends or interests is that the possible profits on the investment cannot be cashed, without interrupting the cash flow. On the other hand, the loss on the investment can be larger than the annually received cash flow from dividends or interest payments.
Cash flow from options
A final often used way of creating positive cash flow from investments, is by writing call options on stocks. To ensure a low risk, the stocks should be in possession.
By writing (selling) call options on stocks that are owned by the investor, the investors receives a premium. The call option obligates the writer of the call options to sell the shares at a predetermined price to the buyer of the call option. When the market price of the stock before or on the expiration date is lower than the predetermined price of the option, the option will expire. The investor (writer of the call option) has a positive cash flow from the call option, without having to sell the stocks.
The more the predetermined price of the call option is above the current market price (with the same expiration date), the lower the received premium will be. But the risk that the call option will be exercised will be lower. This means that the higher the predetermined price, the lower the chance is that the stocks must be sold to the buyer of the call option. Another advantage is that when the call option is exercised, the price that is received for the stocks will also be higher.
The received premium also depends on the period. The shorter the period, the lower the premium that will be received. The advantage of this will be that the chance of exercising is lower.
The advantage of cash flow from writing call options, is that the premium of the written call options creates a positive cash flow. Besides that, the shares will remain in possession of the investor, as long as the option is not exercised.
The disadvantage of creating a cash flow from writing the call options arises when the call option is exercised. The shares will then have to be sold. When the call option is exercised, the market price will be above the predetermined price of the call option. The investor could have had a higher positive cash flow and profit if the stocks were sold on the stock market.
Your cash flow method
Do you have another cash flow creation method? Leave a comment so that other readers can benefit from your cash flow method.