Are the company’s terms of trade favourable? Is Cash flow healthy
The investor must assess whether the company has reasonable bargaining power with its customers and suppliers. Additionally, ensure that most of the company’s profit is not getting stuck in working capital and other fixed assets.
The company should enjoy favorable credit terms with its customers on the one hand and suppliers on the other. These companies collect cash quickly from their customers and enjoy extended credit periods with their suppliers. In contrast, a company with adverse terms of trade will need to extend a lengthy credit period to its customers and pay its suppliers early.
The fair value of a company is the present value of its future Free Cash Flow. The ideal company is one where both operating cash flow (OCF) and free cash flow (FCF) is strong. The first step is to ensure OCF is positive and not significantly lower than profit after tax. Companies can have intermittent negative FCF because of growth capital expenditure. However, a continuous negative FCF is a cause for concern as there could be a misallocation of capital.