How to read Financial Statements Part 3

Part One

Part Two

"There is a huge difference between the business that grows and requires lots of capital to do so and the business that grows and doesn't require capital."

-Warren Buffett

Understanding the Cash Flow Statement

The cash flow statement, as the name suggests, is the record of the movement of cash in and out of a company during a particular period of time. If you were to keep a cash flow, it would consist of cash flowing in from your salary and cash flowing out from your expenses and repayment of debts.

There are 3 parts to the Cash Flow Statment

1. Cash flow from Operating Activities
2. Cash flow from Investing Activities
3. Cash flow from Financing Activities

Cash Flow from Operating Activities 

 

 

It will always begin with Net Income and then adds back in depreciation and amortization. Although these are actual expenses, they do not eat up any cash because they represent cash that was eaten up years ago. For our supermarket, it made $3,300 in net profits for the year. However, $300 was deducted in total for depreciation and amortization. After adjusting for these expense, its actual cash flow from operations would be $3,600.

Cash Flow from Investing Activities

 

Our supermarket might have to spend money on a new store or more factories to produce more products in order to grow the business, in this cash $900 (Capital Expenditure).
Cash flow from investing therefore is usually negative as it reflects how much a company spent to produce future income.

Cash flow from Financing Activities 

This usually includes any dividends paid to share holders, cash used to buyback their shares and repayments on any long term debts.

Net Change in Cash 

 

If we add the Total cash from operating activities, together with the decrease in cash from investing and financing, we will get the Net Increase(or decrease) in cash for the year. The total cash at the end of the year will be derived after taking into consideration the company's cash position at the beginning of the year.

Key things to note with the cash flow statements

1. Is the company generating healthy amounts of cash. Excess cash can be used to payout dividends to reward shareholders or to expand company operations
2. Can the company keep its capital expenditures under control and are they funding their capital expenditure through internal cash flow or debt.
• What % of a company's earning is being used for Capital Expenditure
• Capital Expenditure/Net Earnings x 100%
3. Consistent Share buy backs can indicate a company with healthy cash positions and generates greater value for shareholders
4. Does a company have a fixed dividend policy to reward shareholders.

Note: This is only meant to give investors a brief overview of the main components of a the Cash Flow statement. Actual statements have more variables but if you apply the basics principles and practice reading them, it will become easier with time.