CASH IS KING. OR IS IT? Easy explanation of the Cashflow statement (including a real example) Ep. 8

To be able to analyze dividend stocks, you must be able to analyze the financial statements of a company. This is part of your ‘due diligence’. So when someone is telling you to do your own research, this is what they mean.

There are three important financial statements:

Income statement: in this video I explained step by how to analyze an income statement:
Balance sheet: in my previous video I went over the balance sheet and explained step by step what to look for:
Cashflow statement: and in today's video I will take you step by step through the process of how I analyze a cashflow statement.

The cool thing about the cashflow statement is that is basically zooming in on what happened with the cash in the company. So how did the cashbalance on the balancesheet change from x in 2018 to y in 2019. More on that later on.


Cashflow
Lets first begin with getting the terminology out of the way. What is cashflow and what is a cashbalance?

Cashflow is often compared to flowing water. For example if you take a lake there is usually a river with water flowing into that lake and a river flowing out of that lake. The inflow and outflow of that water into and out of the lake can be compared to money(cash) flowing into and out of a company. And the water that is in the lake at any given time can be compared to cash on the balance sheet.

Examples of cash flowing into a company are customers that are paying but also debt that the company has issued. Examples of cash flowing out of a company are when the company is paying their suppliers, paying down debt or paying out a dividend.

Three types of cashflow
The cashflow statement distinguishes three types of cashflow:

Cashflow from operations: this is cash from customers (in), cash to suppliers (out). This is the most important part of the cashflow statement because this is the lifeblood of the company. The cashflow from operations should be positive.
Cashflow from investments; this includes acquisitions (out), buying properties (out), sale of assets (in). This should be negative, because investments are made to keep the company moving forward and increasing their revenue. If it is positive then that is not a good sign.
Cashflow from financing; includes cash from issuing debt (in), repaying debt (out), dividends (out). This category should also be negative. If it is positive it means the company has taken on more debt than they have paid down.

To sum-up a good cashflow statement looks like this:
Cashflow from operations is positive
Cashflow from investing is negative
Cashflow from financing is negative

Cashbalance
Like I explained at the beginning, the cashbalance is the amount of cash that is shown on the balance sheet (current assets) at any point in time.

If a company had 5.5 billion of cash on the balance sheet in 2018 and 6.5 billion in 2019 then the cashflow statement shows where that difference of 1 billion came from. At the bottom of the cashflow statement there are 3 lines: net change in cash, cash at beginning of period and cash at end of period.

The first line, net change in cash, is a sum of the cashflow from operations, investing and financing. The second line is the amount of cash that was on the balance sheet at the beginning of 2019 (that is the same amount as the end of 2018), so in our example the would be 5.5 billion. The endbalance is the startbalance+net change in cash, so 5.5+1 billion is 6.5 billion.

Free cashflow
At the very bottom of the cashflow statement the free cashflow can be found.

The free cashflow represents the cash that is left over for creditors and investors after deducting all the operating expenses and investments in capital (maintenance of equipment, buildings etc).

This is important for us dividend investors because this is a good way to measure how much of their free cashflow is used to pay out the dividends. So in order to measure the safety of the dividends we can calculate the free cashflow payout ratio by dividing the dividends by the free cashflow.

BUT an increasing free cashflow doesn’t always have to be a good thing, because if most of that free cashflow came from a positive cashflow from investments and financing then that will be cutting into the future earnings potential of the company.

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Disclaimer:
I am not a financial adviser. These videos are for entertainment, inspiration, and educational purposes only. Investing of any kind involves risk. I am only sharing my opinion with no guarantee of gains or losses on investments. Please consult an appropriate adviser and do your own research before making any decisions on anything.

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