Cash Flow Analysis

The cash flow analysis refers to the examination or analysis of the different inflows of the cash to the company and the outflow of the cash from the company during the period under consideration from the different activities, which include operating activities, investing activities, and financing activities.

IronMount Corp and BronzeMetal Corp (both hypothetical companies) had identical cash positions at the beginning and end of 2007. Each company also reported a net income of $225,000 for 2007. Which company is displaying elements of cash flow stress? What factors cause you to reach this conclusion?

Let’s say Company ABC has just started a business and earned revenue of $100 this year. And as per the record, their expenses are $60. Now in general terms, you would say Company ABC has made a = $(100 – 60) = $40 profit. However, in the case of Company ABC, it’s seen that they have a revenue of $100 this year, but they have collected only $80 this year, and the remaining they will collect in the next year. In the case of expenses, they have only paid the US $50 this year and the remaining in the next year. So if we calculate the net cash inflow this year, it would be $(80 – 50) = $30.

So, even if Company ABC has made a profit of $40 this year, its net cash inflow is $30.

In Cash Flow Analysis, we will include the cash related to operations and expenses and incomes from investing and financing activities.

Cash Flow Analysis is divided into three parts – Cash flow from Operations, Cash flow from Investments, and Cash flow from financing. We discuss each of these by one.

#1 - Cash flow from Operations

Cash flow from the operation means accounting for cash inflows generated from the normal business operations and their corresponding cash outflows.

There are two ways to calculate cash flow from operations – 1) the Direct and 2) the Indirect method.

The indirect method is used in most cases.

Here we will look at only the indirect method for computing cash flow from Operations.

Computation of Cash Flow from Operations:

• Before you start thinking about cash flow statement analysis, look at the income statement first. Now start with net income.
• You need to add back non-cash expenses like depreciation, amortization, etc. The reason behind adding back non-cash expenses is they are not actually expensed in cash (but in the record).
• It is the same with any sale of assets. If there is any loss on the sale of assets, we need to add it back, and if there is any gain on the sale of assets, we need to deduct it.
• And then, we need to take into account any changes in non-current assets.
• Finally, we need to include changes in current assets and current liabilities (in current liabilities, we shouldn’t include dividend payable & notes payable.

Learn Cash Flow from Operations in detail - Cash Flow from Operations

Colgate's Cash Flow from Operation Example

source: Colgate SEC Filings

• Even though Colgate's Net Income in 2015 was $1,548 million, its cash flow from Operations seems to be in line with the past.
•  If you look closely at the 2015 Cash Flow from operations, there is a charge for Venezuela's accounting change that has contributed $1,084 million in 2015. It was absent in 2013 and 2014. If you remove this charge, Colgate's Cash Flow From Operations will not look too exciting.

#2 - Cash Flow from Investment Activities

Other than operations, the company also invests in assets that can provide them with greater returns. Cash Inflow from investing activities would include purchasing long-term assets or securities or selling them (except cash) and providing and taking loans. We need to find out how many cashless (loss or gain) activities are done during the period so we can take them into account while ascertaining the net cash inflow.

Though there is not much to be talked about here, two things should be taken into account.

• First, we need to add back losses (if any) while selling long-term assets or marketable securities. These losses should be added back as there is no cash outflow for the losses.
• Second, we need to deduct profits (if any) while selling long-term assets or marketable securities. These profits should be deducted because there is no cash inflow for the company's profits.

Learn Cash Flow from Investments in detail - Cash flow from Investments

Colgate's Cash Flow from Investment Example

source: Colgate SEC Filings

• Colgate’s Cash Flow Analysis from Investing Activities was at -685 million in 2015 and -859 million in 2014.
• Colgate's core capital outlay was -691 million in 2015 as compared to -757 million in 2014.
• In 2015, Colgate got proceeds of $599 million from the sale of marketable securities and investments.
• Additionally, Colgate received $221 million from selling the South Pacific laundry detergent business.

#3 - Cash Flow from Financing Activities

• First, if there is any buying back or issuing stocks, it will come under financing activities in cash flow analysis.
• Borrowing and repaying loans on a short term or long term issuing notes and bonds, etc.) will also be included under financing activities.
• We also need to include dividends paid (if any). However, we need to ensure that we don’t include accounts payable or accrued liabilities (because they would be taken into account in net cash flow from operating activities).

Colgate's Cash Flow from Financing Example

source: Colgate SEC Filings

• Colgate’s Financing activities have been pretty stable for 2015, 2014, and 2013.
• Colgate’s principal repayment on debt was -9,181 million in 2015, and its issuances stood at $9,602 million.
• Colgate has a stable dividend policy. They paid -1,493 million in 2015 and -1446 million in 2014.
• As a part of its share buyback program, Colgate regularly buys back shares. In 2015, Colgate purchased $1551 million worth of shares.

Learn Cash Flow from Financing Activities in detail - Cash Flow from Financing Activities

Let's go back to the earlier cash flow analysis example that we started with – IronMount Corp and BronzeMetal Corp had identical cash positions at the beginning and end of 2007. Each company also reported a net income of $225,000 for 2007.

Perform its Cash Flow Analysis.

IronMount and Bronze Medal, both companies, have the same end-of-the-year cash of $365,900. Additionally, changes in cash during the year are the same at $315,900. Which company is displaying elements of cash flow stress?

• We note that Cash Flow from Operations is negative for IronMount at -21,450. Gain on equipment sales is deducted as this is not an operating cash flow.  IronMount sale of equipment adds 307,350, contributing to the cash increase.
• On the other hand, when we look at BronzeMetal, we note that its cash flow from operations is strong at $374,250 and seems to be doing great in its business. They are not relying on the one-time sale of equipment to generate cash flows.
• With this, we conclude that IronMount is showing signs of stress due to low core operating income and its reliance on other one-time items to generate cash.

source: ycharts

• Cash Flow From Operations - Google’s Cash Flow from Operations is generated from advertising revenues from Google properties and Google Network Members' properties. Additionally, Google generates cash through sales of apps, in-app purchases and digital content, hardware products, licensing arrangements, and service fees received for Google Cloud offerings. Google's Cash flow from operation shows an increasing trend primarily due to an increase in Net Income. Google's Net Income was $14.14 billion in 2014, $16.35 billion in 2015, and $19.48 billion in 2016.
• Cash Flow From Investing Activities - Google's investing activities primarily include purchasing marketable securities, cash collateral paid related to securities lending, and spending related to acquisitions.
• Cash Flow from Financing Activities - Cash Flow from Financing is driven by proceeds from the issuance of debt, debt repayments, repurchases of capital stock, and net payments related to stock-based award activities. Google’s Cash Flows from Financing activities are decreasing each year due to increased shares repurchased. In 2016, Google repurchased shares worth $3.304 billion compared to $2.422 billion in 2015.

source: ycharts

• Cash Flow from Operations - Amazon’s Cash Flow from Operations is derived from the cash received from consumer, seller, developer, enterprise, and content creator customers, advertising agreements, and co-branded credit card agreements. We note that Cash Flow from Operations has been increasing steadily. It is primarily due to the increase in net income. Amazon's Net Income was -$241 million in 2014, $596 million in 2015, and $2,371 million in 2016.
• Cash Flow from Investing - Cash Flow from Investment for Amazon comes from cash capital expenditures, including leasehold improvements, internal-use software and website development costs, cash outlays for acquisitions, investments in other companies and intellectual property rights, and purchases, sales, and maturities of marketable securities. Cash Flow from Investing was -$9.9 billion in 2016 compared to -6.5 billion in 2015.
• Cash Flow from Financing Activities - Amazon’s Cash Flow from Financing activities comes from cash outflows resulting from the Principal repayment of long-term debt and obligations related to capital and financial leases. Amazon’s cash flow from Financing Activities was -$2.91 billion in 2016 and -$3.76 billion in 2015.

source: ycharts

• Cash Flow from Operations - Box generates Cash Flow from operations by providing its Software-as-a-Service (SaaS) cloud content management platform to organizations to manage their content along with secure and easy access and sharing of this content. Unlike the other two examples of Amazon and Google, Box's Cash Flow from Operations is weak due to continued losses over the years. Box CFO was -$1.21 million in 2016 compared to -$66.32 million in 2015.
• Cash Flow from Investing Activities - Box Cash Flow from Investing activities was at -$7.57 million in 2016 compared to -$80.86 million in 2015. It was primarily due to reduced capex in the core business.
• Cash flow from Financing Activities - Box Cash Flow from Financing Activities has shown a variable trend. In 2015, Box came up with its IPO, and therefore its Cash Flow from Financing increased to $345.45 million in 2015. Before its IPO, Box was financed by Private Equity Investors.

Even if cash flow analysis is one of the best tools for investors to find out whether a company is doing well, cash flow analysis also has a few disadvantages. We will have a look at them one by one.

• One of the most significant things about cash flow analysis is that it doesn’t consider any growth in the cash flow statement. The cash flow statement always shows what happened in the past. But past information may not be able to portray the right information about a company for investors interested in investing in the company. For example, if the company has invested a large amount of cash into R&D and would generate a huge amount of cash through its ground-breaking idea, these should come in the cash flow statement (but they don’t get included in the cash flow).
• Another disadvantage of the cash flow statement is this – it can’t be easily interpreted. For example, it's difficult to understand from a cash flow statement whether a company is paying off its debt or investing more in assets. If you ask any investor to interpret the cash flow statement, he wouldn’t be able to understand much without the help of the income statement and the other information about transactions that occurred throughout the period.
• A Cash Flow Statement is inappropriate if you want to understand the firm's profitability because, in the cash flow statement, non-cash items are not considered. Thus, all the profits are deducted, and all the losses are added back to get the actual cash inflow or outflow.
• The Cash Flow Statement is articulated based on the cash basis of accounting and completely ignores the accrual concept of accounting.

To understand a company and its financial affairs, you need to look at all three statements and all the ratios. Only cash flow analysis would not be able to give you the right picture of a company. Look for net cash inflow, but also ensure you have checked how profitable the company has been over the years.

Also, cash flow analysis is not an easy thing to calculate. If you want to calculate cash flow analysis, you need to understand more than the basic level of finance. And you also need to understand financial terms, how they are captured in the statements, and how they reflect the income statement. Thus, if you want to do a cash flow analysis, first know how to see the income statement and understand what to include and what to exclude in the cash flow statement.

• Operating Cash Flow Formula
• Retained Earnings Meaning
• Mistakes in DCF
• Price to Cash Flow