In this video, we’re going to teach you how to read and analyze a cash flow statement.
This is a critical financial document that every business should have, and it’s a great way to start your financial analysis career.
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If you’re a beginner in business, then this video is for you!
We’ll walk you through the steps of reading and analyzing a cash flow statement, and give you tips on how to use it for your business.
After watching this video, you’ll be able to understand and analyze a cash flow statement like a pro!
What is a Cash Flow Statement? A Cash Flow Statement is a financial statement that summarizes the movement of cash and cash equivalents that come in and go out of a company.
The Cash Flow Statement summarizes the movement of cash and cash equivalents that come in and go out of a company. It measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses.
There are three main components to be found on every Cash Flow Statement, those are:
Cash flow from operating Activities, which is the amount of cash flow the business generates from daily operations, such funds received from the sale of goods and services, interest payments, income tax payments, rent payments, and so on.
Second, Cash Flow from Investing Activities which is the amount of cash flow the business generates from investments, such as buying or selling assets for the company, loans made to vendors or received from customers, payments related to mergers and acquisitions and so on. Typically the number in this section is negative as the company has to spend money to invest on itself or acquire other companies.
And last, Cash flow from Financing Activities Which is the amount of cash flow the business generates from taking new debt or raising new debt, as well as paying dividends and buy back stock. Typically this number is negative as well , however you will notice that in Amazon’s case this number is positive some times, like in 2017, and 2021 which is normal. That usually happens if the company is taking on debt or doing dilution to raise money.
Another key component to take note of is the Free Cash Flow, which is the cash left after a company pays for its operating expenses and capital expensure. This metric is very important, and it serves as a measure of profitability, thus is a key indicator of the Financial Health of the company.
Now that we covered the main components on the cash flow statement, let’s dive a bit more into it and check the subcategories.
Starting with the Cash Flow From Operating activities, the first section we see is Net Income. As you may recall from covering the income statement Financial report, Net income is the money the company makes after deducting all the costs and taxes.
Next is Depreciation and Amortization. Depreciation refers to the reduction in value of a tangible asset like inventory and equipment, and amortization refers to the reduction in value of an intangible asset such as goodwill, licenses, trademarks and so on. This is not a cash expense , meaning the company does not have to pay the amount in cash, but a loss in physical value, still it has to be accounted for, thus it has been reported in this section.
Deferred taxes represent the company’s negative or positive amounts of tax owed.
Changes in working capital tracks the net change in operating assets and operating liabilities across a specified period. To calculate the working capital you need to subtract Current Operational Liabilities from Current Operational Assets.
Working Capital = Current Operational Assets – Current Operational Liabilities.
A Positive working capital shows that your business has sufficient liquid assets to pay off immediate debts.while a negative working capital shows that the company would struggle to pay immediate debts if restricted only to current assets.
You can expand Changes in the working capital and look at more categories such as account receivables, account payable, accrued expenses ,inventory and other assets. But the number to focus more here is the changes in the working capital as a hall.
TO summarize the cash from operating activities you add the Funds from operations with the changes in the working capital and you get your cash from operating activities, in Amazon’s case this is 46.33 Billion for 2021.
Moving to Cash from investing activities, as mentioned earlier is the amount of cash flow the business generates from investments. There are 3 subcategories in this section worth focusing on.
The first one is the cash from purchases or sale of businesses, which reveals the cash received from the disposal of property, plant and equipment, businesses and/or other subsidiaries as well as the purchase or acquisition of a business. If we expand we will see two categories as well. USually that number for most businesses is negative however in Amazon’s case its positive as the company is raising quite the funds from the sale of fixed assets, while is spending quite a bit on buying new companies.
The next subcategory is cash from purchase or sale of investments. Again there are two categories in the list one is the purchases and one is the sales. A company like Amazon is heavily invested in long and short term investments as you can see from the figure of money that is on the report, both on the purchase and sale side.
The third subcategory is the capital expenditures, which is a key metric on the cash flow. Capital expenditures measures the funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment. This number is important as this shows how much money the company needs to spend to maintain its current business.
The last part of the cash flow statement is the cash from financing activities. These activities are been broken down to 4 subcategories:
the issuance or retirement of stock, which represents the net change in the carrying value of common and preferred stock.
The insurance or retirement of best, that represents the net change in the Total Debt of the company.
The total cash of dividends that were paid out, keep in mind not all companies pay dividends, and last other financing cash flow items that can generate cash for the company.
Two parts to focus here:
First the issuance of debt, if you click thre you will get a new category: the issuance of long term debt. If that number is negative which is for quite a few years in the case of Amazon, means that the company is paying of its long term debts, spending money towards that, and reducing them, if the number is positive means that the company is adding more debts which as you can see it happened in 2021 for Amazon. If you click further you can see how much debt amazon added for the year of 2021 and how much the company spent towards reducing its debts.
Second is the issuance of stock. In the case of Amazon the numbers here are zero so let’s use another income statement to better explain why this category is important. Lets use Twitter.
Twitter over the last few years has generated cash from selling common and preferred stock, for those who are unaware the main difference between preferred and common stock is that preferred stock gives no voting rights to shareholders while common stock does. Also Preferred shareholders have priority over a company’s income, meaning they are paid dividends before common shareholders. When a company sells stocks to raise money they dilute the company’s ownership which has negative implications for a simple reason: A company’s shareholders are its owners, and anything that decreases an investor’s level of ownership also decreases the value of the investor’s holdings.Dilution also reduces the company’s earnings per share (EPS), which often depresses stock prices in the market.
A negative Free cash flow indicates an inability to generate enough cash to support the business. Now in the majority of cases this is a negative sign however that alone can not determine if a company is doing good or bad. In the case of amazon, the Net income of the company is growing over the years and the company is investing heavily on itself, so having a negative free cash flow for a year is not such a red flag.
Now that we analyzed all the categories and subcategories of a Cash Flow statement and we know what each one of them represents let’s talk about the key things that you want to see in them:
First the Cash from operating activities, over the years we want to see that number growing. This shows that the company;’s operations over the years generate more cash, which means their business is growing.
Last, it’s always a great idea to pay attention to the Capital expenditures as these are the costs associated with maintaining existing property and equipment.
Aside from the three key points mentioned, digging more to subcategories can explain why some of the numbers make no sense, and red flags come up.
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