Listen to Your Cash flow
Your Bond Investment’s Vital Signs.
Monitoring the financial health of your investments is as important as checking various parameters to check your physical health. And there are various tools or parameters to check the ongoing health of your investments in fixed-income securities like bonds.
One of the parameters to check the fitness level of your investments in bonds, or any other fixed-income instrument like non-convertible debentures and corporate bonds, is the cash flow statement.
Bonds are a popular investment choice for investors seeking relatively low-risk, stable returns.
A key reason to monitor cash flows is to ensure that you receive regular interest payments. When you invest in a bond, you essentially lend money to the bond issuer, who promises to pay you interest on that loan at periodic intervals – say monthly, quarterly, semi-annually or annually.
Of course, there may be no periodic payments in a zero-coupon bond. Here, the bond is sold to you at a discount to the face value, and redeemed at face value. This difference between the purchase and redemption prices is your return on a zero-coupon bond.
Cash flow refers to the amount of money coming in and going out of a business or investment. One can check whether the bond issuer is complying with the projected cash flow, if any, mentioned in the offer document.
Or, if you are a financial expert, you may want to assess if the company or bond issuer's performance is in line with the cash flow forecasting.
In short, you won't be wrong if cash flow is termed as the financial pulse beat of an organization.
How to check a bond’s pulse?
Many factors can affect the cash flow of a manufacturing company.
There are three sources of Cash flow for a company.
Cash flow from operating activities: This is the cash generated or used in the company's normal business operations, such as sales and collections from customers, payments to suppliers and employees, and other expenses related to the company's day-to-day activities.
Cash flow from investing activities: This represents the cash generated or used in investments in long-term assets, such as property, plant, and equipment, and investments in other companies, financial assets, and other long-term investments.
Cash flow from financing activities: This represents the cash generated or used in financing the company's operations, such as raising capital through the issuance of debt or equity, paying dividends to shareholders, repurchasing company stock, and paying back loans or other debt obligations.
These are the primary parameters that credit rating agencies also evaluate while assigning or reviewing the rating for fixed-income securities.
Of course, cash flow from operating activities is a key monitorable for a manufacturing company. Raw material price movements, operating costs, supplier credit, inventory, trade receivable days, operating margins, capital expenditure and the working capital cycle are key components within this.
Debt Watch
One also has to monitor whether too much debt is being added to the books.
Interest payments on debt can impact cash flow. Companies with high levels of debt may struggle to generate sufficient funds to service their debt. This can happen when economic conditions change.
A mismatch in cash flow can severely impede the ability to comply with debt covenants and lead to unpleasant meetings with lenders and a review of credit ratings.
Monitoring cash flows help you identify any potential problems early and take appropriate action.
Identify Potential Defaults
Apart from monitoring interest payments, cash flows can help you identify potential defaults. If the bond issuer is experiencing financial difficulties, it may be difficult to make regular interest payments or repay the principal amount at maturity.
Keeping a watch on cash flows can help you identify any issues early, giving you time to take action, such as selling the bond before a default occurs and finding another avenue to invest your funds.
Adjust Investment Strategy
Monitoring cash flows can also help investors tweak their investments based on their financial goals and risk tolerance. For example, if you are nearing retirement and need a more stable income stream, monitoring cash flows can help you identify bonds that offer a more predictable income stream.
On the other hand, if you are a more aggressive investor looking for higher returns, monitoring cash flows can help you identify bonds with a higher credit risk but potentially higher returns.
A fixed-income instrument gets its income stream from cash flows generated by the issuer. So, it is very important to understand where this money comes from and the factors that influence it.
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