To invest in companies I need to find out more about cash flow. Sometimes cash flow is defined and calculated by
cash flow = net income + depreciation costs - capital expenditures ... (1)
while sometimes it is defined and calculated by
cash flow = net income + depreciation costs ... (2)
such as in the case of Value Line. However, isn't it true that without subtracting capital expenditures, the cash flow calculated this way can be largely inaccurate?
For example, if a company is buying $100,000 worth of computer each year for its employees, and next year another batch of employees' computers will need to be replaced. So this year, the capital expenditure is $100,000 and assuming for the past 6 years, each year $100,000 was spent and the depreciation portion is
$100,000 / 6 but for 6 years, so it is
$100,000 / 6 × 6 = $100,000. So if the company bought some goods for $1 million and sold it for $2 million, and paid $100,000 for computers, the cash flow is really $1 million in, and $100,000 out, so it is $900,000 and can also be calculated by
cash flow = net income + depreciation costs - capital expenditures ... (1) net income = $2 million - $1 million - depreciation costs = $1 million - $100,000 = $900,000 cash flow = $900,000 + $100,000 - $100,000 = $900,000
and it is accurate.
But if we use (2)
cash flow = net income + depreciation costs ... (2) = $900,000 + $100,000 = $1 million
and cash flow is inaccurate, off by the $100,000 amount. So isn't (2) not good and if we use it or Value Line uses it, then it is not so accurate and should we really use (1)? The example above is off by $100,000 but for similar reasons, it could be off by $200,000 or $300,000.