How Do You Read a Cash Flow Statement? | Phil Town

hi this is Phil town for rule 1 investing we're going to talk about the all-important super critical cash flow statement alright there are just as a reminder three financial statements that are all important and all of them show us different pictures of the company now if you want to learn to be an investor you've got to learn to you know speak investor knees or whatever you'd say right investor ease though the language of investing the language of business is found in these three financial statements the balance sheet the income statement and the cash flow statement now cash flow statement is used to determine if the company we're researching is healthy that's what we want to understand from the cash flow statement is it healthy from this very important point of view do you have the cash coming through so that you don't run out of money that's the critical aspect of the cash flow statement earnings statement tell you if you're profitable the balance sheet tells you that you have a company that's worth more than what you owe and the cash flow statement is there to show you that the cash is available for you to function so the cash flow statement is kind of like looking at the gas gauge on your car right do you still have gas in the car now when you look at the cash flow statement there are some pretty big red flags that jump out at you when you see the cash flow statement right on the top line of it it's going to say net income and you're going to get a number from the income statement that's the same on both of those two statements so the cash flow statement takes the net income from the income statement and it begins the cash flow statement with it and what that does is it says oK we've got this net income this GAAP accounting this sort of fictional number of how much money we made let's turn that into real dollars and see if that's what we've actually got in the bank so the first big red flag to work before when we're looking at a cash flow statement is you go down to the first big major bold section of it which is operating cash flow or cash flow from operations and it's a smaller number than the net income or a real red flag is its negative number that means you're losing cash as you're going forward and that's a huge red flag now another big big big red flag on a cash flow statement comes down to the last section which is about financing cash in other words if you have gone out and borrowed money that'll be in that third section down there and if you've gone out and raised money by selling stock that'll be in there now here's a red flag that really jumps out at me like when I looked at a company like GM and you see that they are paying dividends so this is money paid out and it's in that finance section of the cash flow they're paying dividends and you notice that they don't have the cash flow out of operating cash to pay the dividends so where did they get the money the dividends are flowing out to investors but the money isn't coming from actual operations where is it coming from and then you see that they're borrowing as much money as they're paying out in dividends holy smokes gigantic red flag now there are some gotchas out there that are beyond that but those are - the really really big ones that you want to watch for now let me give you a couple of examples of really good cash flow statements and really bad cash flow statements I just mentioned GM take a look at rule number one my book that I wrote that got to the top of the bestseller list goes into this in the GM example where GM was having a terrible time with cash flow and still paying out those dividends every year to kind of create a fraudulent experience for the investors I mean the investors are looking at this and going hey GM must be fine because I'm still getting my really nice dividend when in fact GM was borrowing money from over there someplace and may never be able to pay that loan back and go bankrupt in order to pay you your dividend so you end up paying about $80 a share for this company to get you a little dividend and then the company goes broke that's a horrible horrible problem and you would have seen that in the cash flow statement now Apple computers exactly the opposite they have huge cash flow giant cash flow that comes in cash flow that's way bigger even than their earnings and so when you're looking at a company like Apple you can put a value on it that's maybe larger than what it would expect to see from just earnings growth because it's so much cash Microsoft back in its heyday same kind of thing which is growing cash like a maniac so really good companies produce real good cash flow growth and of course some point that turns into free cash flow that can go in the pocket of the investors now we love cash flow growth and we love to see what that growth rate is so one of the things we do with rule one investing is we look at the cash flow growth both in terms of operating cash flow and free cash flow and we compare that to our growth rate on earnings and see if it's the same if it's the same la lovely we love that very much and if they're the same we could use that as a way of figuring out the value of the business down the road so if you like what you've seen here you guys subscribe to my channel for more content teach you all about how the best investors in the world do this I'm Phil Towne time to go play

Channel: Rule #1 Investing

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Id: X17bUV-EfIM

Length: 5min 18sec (318 seconds)

Published: Wed Jan 06 2016