The most important investing skill you'll ever learn: The Cash Flow Statement
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How to Read a Cash Flows Statement
Welcome all Profit Zone subscribers to one of the most useful posts you will ever read.
Here’s the problem with the investing world. People are lazy. Do you know how I know that? Because posts telling others EXACTLY what stocks they think you should buy get much more engagement than posts showing others how to find quality stocks. It makes no sense.
The saying goes “give a man a fish and he’ll eat for a day. Teach a man to fish and he’ll eat for a lifetime”.
Yet for some reason, all of these investors are content with only eating for a day.
It’s sad to see the number of investors who refuse to do even a little bit of digging. There are many who will invest in a stock just because someone online said so…
If this is you, and I know there will be a few of you, I’m writing this post to help set you straight.
By the time you’re done reading this, you’ll have 85% of the tools you need to make better financial decisions. The best part is that it doesn’t take that long to learn, but it could change your life forever and that’s not an overstatement.
The day I learned how to read a cash flow statement was the day I leveled up as an investor.
Remember this as we continue:
“Ratio will give you the clues. Statements will give you the answers"
If you want to stop guessing with your hard-earned money, keep reading.
The Purpose of the Cash Flow Statement (CFS)
The Cash Flow Statement is a tool used to manage a company’s finances by tracking the cash flow in and out of the business. It shows the source of cash and helps monitor cash inflows and outflows. In other words, it gives you a better idea of how efficiently a company handles its money.
I’m sure you’ve heard the saying “Cash is king”.
If cash is king, then the Cash Flow Statement is the King’s Castle.
3 Components of The CFS
Let’s break them down
FYI: At the end of this post you’ll find an example of a cash flow statement. I suggest using the information in this post to try and figure out how the example company handles its cash.
Operating Activities (AKA Cash Flow from Operations CFO)
By far the most important indicator of the efficiency of cash generation for a company. This section measures the cash that the company generates through the sales of its products minus the cash paid to any employees, suppliers or interest on debt and taxes paid to the government. In other words, it measures a company’s operating profit.
This section is fairly straightforward. A growing cash flow from operations indicates a growing business, and a shrinking cash flow from operations indicates a shrinking business.
Typically we want to stay away from companies who show negative numbers in this section of the CFS, because as investors we don’t want to be investing in companies that are losing money.
Investing Activities (Cash flow From Investing CFI)
This section of the CFS includes anything related to the purchase and sale of long-term assets. Assets such as property, plant, equipment, patents, loans made or received and payments related to mergers & acquisitions.
This section of the CFS is slightly different than operating activities because it is common to see negative numbers in Cash Flow from Investing.
Why? Because companies are constantly investing in themselves. Recycling earnings back into the business to buy long-term assets will have a negative impact on their cash position. If you see a negative number in this section, don’t be alarmed. It can be a good thing for long-term growth and expansion.
On the flip side, you will see positive values if the company is receiving cash from its investments or selling off its assets.
Financing Activities (Cash Flow from Financing CFF)
Last but not least, the financing section of the CFS. This is where you’ll find how much money the company has raised through share or bond issuances, as well as other forms of debt financing.
If the company decided to take out a loan, you’d see the amount of the loan in this section as a positive value, because it’s money into the business. You would also find how much they paid in dividends to shareholders like you and me, as well as any principal repayments on their outstanding debts.
A positive cash flow from financing means that the company is raising money, which is a good sign. All great businesses need to raise some sort of cash so that they can continue growing and remain competitive in their market.
Example of a Cash Flow Statement
An important thing to remember is that all 3 sections of the CFS are dependent on each other. Analyzing only 1 of them would be misleading and wouldn’t give you the full story of how the company manages its money.
One thing to take from this is that cash is king. And luckily for you, the CFS states exactly how much Free Cash Flow the company has on hand.
I love investing in companies that have enough Free Cash Flow to continue paying (and growing) their dividends while also having enough to invest in the business long-term to facilitate growth.
As I mentioned in the beginning:
“Ratio will give you the clues. Statements will give you the answers"
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