Cash isn’t king.
Cash flow is king.
To determine if a company’s cash flow is “king” you need to understand how the read the cash flow statement.
I’ll show you how.
Thread:
Cash flow is king.
To determine if a company’s cash flow is “king” you need to understand how the read the cash flow statement.
I’ll show you how.
Thread:
Cash flow statement has three sections:
1) Cash from operations
2) Cash from investing
3) Cash from financing
1) Cash from operations
2) Cash from investing
3) Cash from financing
1) Cash from operations:
This is the most crucial section.
Cash from operations refers to how much a business makes from its day to day activities.
To figure this out, you start with the net income and add back non-cash items.
This is the most crucial section.
Cash from operations refers to how much a business makes from its day to day activities.
To figure this out, you start with the net income and add back non-cash items.
What are non-cash items?
Things like amortization.
Amortization is an expense on the income statement to “approximate” the replacement value of machinery but it’s not actual cash the company pays out. So it’s added back on the cash flow statement.
Things like amortization.
Amortization is an expense on the income statement to “approximate” the replacement value of machinery but it’s not actual cash the company pays out. So it’s added back on the cash flow statement.
Cash from operations also includes changes to working capital.
Let’s assume I own a business and my beginning of the year inventory is $1M and end of year inventory is $2M.
How would this impact cash flow?
Let’s assume I own a business and my beginning of the year inventory is $1M and end of year inventory is $2M.
How would this impact cash flow?
If you think about it, what really happened was on a NET basis, I bought $1M more of inventory during the year. Sure I made sales, but since my overall inventory increased, it would mean that I would have PAID (assuming everything was bought in cash) $1M more this year.
This has a negative effect on my cash flow statement.
Meaning I will reduce my balance by $1M to calculate my cash from operations.
You do a similar exercise to go through all current assets and liabilities.
Meaning I will reduce my balance by $1M to calculate my cash from operations.
You do a similar exercise to go through all current assets and liabilities.
Here’s a good way to remember the impact:
If current asset INCREASES during the year, the effect on cash flow is NEGATIVE. Think inventory example above.
If current asset DECREASES, effect on cash flow is POSITIVE.
If current asset INCREASES during the year, the effect on cash flow is NEGATIVE. Think inventory example above.
If current asset DECREASES, effect on cash flow is POSITIVE.
The opposite is true for current liabilities.
If current liability INCREASES during the year, effect on cash flow is POSITIVE.
If current liability DECREASES during the year, effect on cash flow is NEGATIVE.
If current liability INCREASES during the year, effect on cash flow is POSITIVE.
If current liability DECREASES during the year, effect on cash flow is NEGATIVE.
Once you take your net income and add non cash items and add (or subtract) the working capital items, you get cash from operations.
For well run businesses, this number should be positive as it helps pay for other business activities.
For well run businesses, this number should be positive as it helps pay for other business activities.
2) Cash from investing:
Cash from investing refers to how the business is using its cash to make investments.
If for example, during the year a company buys equipment and machinery, the effect on cash flow will be negative. Because it is paying cash to make a purchase.
Cash from investing refers to how the business is using its cash to make investments.
If for example, during the year a company buys equipment and machinery, the effect on cash flow will be negative. Because it is paying cash to make a purchase.
If, on the other hand, it sells equipment, the effect on cash flow will be positive. Because it will receive money for the sale.
3) Cash from financing:
A company can finance itself using either debt of equity.
Debt would mean going to a bank and taking out a loan.
Equity would be selling shares on the open market to raise funds.
A company can finance itself using either debt of equity.
Debt would mean going to a bank and taking out a loan.
Equity would be selling shares on the open market to raise funds.
If the company is taking on new debt, cash from financing will be a positive since it is injecting cash into the business.
Pay down of debt is a negative as it uses cash to pay back the loan.
Similar effects for equity - ie. Selling shares vs. repurchasing them.
Pay down of debt is a negative as it uses cash to pay back the loan.
Similar effects for equity - ie. Selling shares vs. repurchasing them.
When you add the cash from operations, cash from investing, and cash from financing together, you get the overall change in cash during the year.
What do I like to see?
It depends on the business. Generally:
-large increase in cash from operations. This means the core business is doing well.
-negative cash from investments, which means the company is hopefully buy new equipment, re-investing to grow the business.
It depends on the business. Generally:
-large increase in cash from operations. This means the core business is doing well.
-negative cash from investments, which means the company is hopefully buy new equipment, re-investing to grow the business.
-negative cash from financing, which would signal the company is either paying down its debt or repurchasing shares.
That’s a wrap!
I hope you enjoyed this tweet and learned more about the super important cash flow statement.
If you did, then please:
1) Follow @practical_cpa
2) RT the top tweet to share it with your audience
I hope you enjoyed this tweet and learned more about the super important cash flow statement.
If you did, then please:
1) Follow @practical_cpa
2) RT the top tweet to share it with your audience
I’ve also done breakdowns that are easy to understand for the balance sheet and income statement. They’re posted below:
Balance sheet:
Income statement:
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