What is a cash flow statement? - MoneyWeek Investment Tutorials

they say cash is king and there's a very good reason for that and that is that cash is the lifeblood of any business and it's a crucial part of making investment decisions so let's take a look in this video at roughly what cash flow statements are all about they're often hidden as far as investors are concerned most investors get as far as the profit loss account maybe the balance sheet and then if they're lucky the end of the cash flow statement then away it's a pity that those bits of paper and a set of accounts are not presented back-to-front okay so in this video we're going to do a beginner's guide to what cash flow statements are roughly what they look like without chewing over all the detail and ask some key questions about what they reveal as an investor now this video assumes a little bit of knowledge so if you find when I'm talking about balance sheets I'm going a bit quickly take a look at my video what is a balance sheet and if you find that when I'm talking about profit I'm going a little bit too quickly for you take a look at what is profit and with that caveat let's get on with cash flow statements right what is a cash flow statement well see it this way you could say that a cash flow statement is like running a cine camera over a firm's activities for 12 months whereas balance sheets are a snapshot or what the firm's worth okay a profit and loss account is also a cine camera job it records activity so in this video let's start off with what's the difference between a profit and loss account which a lot of investors like to focus on profits a concept they like the sound of and a cash flow statement given that both are records of what the phone's been up to okay well let's pull out on a sort of map if you like so there's a as a 12 month accounting period most accountants work to 12-month periods okay they can't cope with much more than that so let's say the balance sheet is prepared twelve months apart as a summary statement of where the company is at at that particular point in time and that point in time might be something like the the 31st of December all right so companies like to prepare their balance sheets every 12 months and the balance sheet is a snapshot this video is not about balance sheets but a snapshot of what the business owns - what it owes to give the net position okay now linking those statements of net worth you have a profit and loss account and you also have the thing that investors often overlook a CFS a cash flow statement all right and investors tend to go straight for this it's the first one they come across it's a big page in the accounts they think right let's see what profit the company made and it's not unreasonable to ask that question but be very very careful cash flow statements are at least as important and they're often overlooked okay so let's start off with what's this thing trying to show on what's the link between the story told in the profit loss account this is trading activity the story told in the cash flow statement and these kind of snapshot camera summaries of where the business has got to every 12 months all right if you want to see it this way pier nails and cash flow statements are recordings balance sheets are like pressing the shutter and taking a snapshot okay so let's take three examples and see our cash flow statement could be useful to an investor imagine at the start of the year you are owed 20 million by your customers okay so you've got outstanding receivables of 20 million okay you know the feeling you lend a mate of yours for money in the pub they then owe you that money and you hope to get it back you don't necessarily record it a ledger like an accountant would but nonetheless it's money you are owed so in a balance sheet that'll be an asset of 20 million now let's say during the next 12 months you bill your customers a further 70 million for work you've done so that at the end of the 12 month period you are now owed 80 million okay so is there a story so far you are owed 20 million at the start of this 12-month accounting period okay you've done 70 million worth of work now that is what will appear in the profit and also count probably something like sales or income you build your customers for work done that's what profit loss counselor all about trading activity okay profit loss counts don't worry too much about the dirty business if I should collect in cash it's all about what you've build what's gone out the door it's all about targets hit and you find the end of 12 months you're still owed 80 million by your customers what does that tell you well it tells you that you must have collected 10 million in cash okay because that completes the story otherwise how do you get from there to there alright so you start off Big O 20 million all right you bill 70 so your customers don't pay you all right you're now out 90 million actually when you look up what your customers are you the end of the period is only 80 wait a minute ah we must have received in cash this is not you'll be glad to know an accounting course right but the principle that I'm trying to get across is this in the profit and loss account billing is at 70 million in the cash flow statement cash collected of just 10 million and since that relates to the core operations of the company when we build a cash flow statement I'm not going to do a 4-1 in a moment we'll probably call that an operating cash flow all right and it's it's coming in it's a cash inflow all right so there is a section on cash flow statements called operating cash flows and just as you want profits to be positive you want that to be positive - all right when you look at the cash flow statement if you see a big gap between what's been billed in the profit loss account and what's been collected by way of cash in other words a big gap between firms operating profits or net income all right depending on which version of the cash flow statement use and the cash coming in the cash inflows more proactive it is there's big gap there it can be a warning signs right away right you need to know more why is there such a big gap okay could it be being a bit slow on the uptake when it comes to building on customers and that could create a problem because if I go bust for they've paid us we're in trouble right so one example of how cash flow statements reveal a rather different picture profit loss counts let's look at another one right firms don't just trade they buy assets to use in their business okay so how about this idea this is just really to show you the link and where cash flow statements fit into the picture now this is a story that's changed the facts a little bit well let's say at the start of the year we buy a nice big juicy asset for 10 million okay now how the accountants you put together profit loss accounts deal with that what they do is they ask the directors to sit down and say right you've bought an asset for 10 million how long do you think that'll last how long you use that in your business let's say the directors say 10 years well in the profit loss account believe it or not that judgment I think the asset will last 10 years is booked against profits in the following 12 months okay in other words the profit loss account is all about what assets have been used okay not necessarily what you've paid for so let's cut a long story short and I deal with that topic in more detail in another video the profit and loss account will capture any depreciation or amortization as the Americans call it and we're going to say that's 1 million I'll go in the profit and also gal ok that means at the end of the 12-month period in the balance sheet you'll have an asset recorded at 9 million the so called net book value that's the opening book value Ted all right - any wearing out or usage called depreciation to give 9 but in the cash flow statement none of this messing around on this mmm I think it will last 10 years let's book a million pound charge oh no in the cash flow statement yeah pay 10 million year book 10 million all right so in this year in a way it's many more years to come by in this year the cash flow statement will show cash out of the full 10 million there's another quite big difference because I gotta make it up the profit loss account there's been this charge at 1 billion in the cash flow statement there's a great wall up of 10 million and that's going to produce quite a different net result in the two statements these are cash flow statements pretty useful because getting a different picture as to what's going on in the business and people who like cash flow statements and say you're getting more reliable picture from the cash flow statement because you can't argue with cash flow it's difficult to mess around with cash flow this judgment involved okay so not surprisingly in a cash flow statement there's a section devoted to what are called investing cash flows where companies buy and sell fixed assets focusing on cash in cash out none of this messing around with depreciation amortization okay let's do one third example and then see how this would all be pulled together in this kind of beginner's guide statement how about how about moving on through a company because their company's trade and they buy assets they want to use in the business to generate more revenue and sold what about a company that starts with 1 million pounds of outstanding debt ok by the end of the year it has cleared it down to nothing ok now if the company simply writes a check to clear a 1 million pound obligation or liability the profit loss account which are nothing there is no trading effect there you've just literally taken an obligation and clear it away using cash so cut long story short don't worry this isn't an accounting course and doesn't need to be cut long story short the profit and loss account will show nothing the cash flow statement will show the cash out required to clear that debt of 1 million so again pick up the profit loss account you'll see very little in relation to this transaction alright because it doesn't add a profit or create a loss look at the cash flow statement let me see a 1 million pounds of cash going out to clear the day alright so you can see there is a bit of a story in the cash flow statement about how the business is financed so not surprised me the third and final heading case wondering how many there are the cash flow statement deals with financing activities right so where we got to so far all I've done is give you three examples of how our cash flow statement might be put together all right we need a section that deals with operating cash flows those are the ones related to directly trading day in day out for a living we need a section devoted to investing cash flows buying and selling fixed assets ok long term assets buying or selling businesses we did a section devoted to financing that's for example issuing debt which brings cash in repaying debt cash goes out issuing shares catch in share buybacks cash out or from the company's perspective don't forget all right so that's in fact what cash flow statements do so without going into the full glorious detail of a whole cash flow statement I'm not sure how many people would still be watching me but I did that with a pen and a whiteboard what we can do is say when you pick up a cash flow statement as an investor you can get straight in a look for three key headings all right you're fine in a cash flow statement there is a heading devoted to operating cash flows there's a section devoted to investing cash flows and there's a section devoted to financing cash flows all right and these could be positive or negative you'll find those sub the subheadings underneath but these are the big important ones in bold and then you'll find there is a net cash flow which is the result positive or negative of adding up these numbers now I've used X's okay so that could be positive or negative back be positive or negative back be positive negative to give a positive overall cash flow for the year a story or where the cash is flowed into the business or flowed out of it but let's take my numbers just now and do a quick compare and contrast now you might have forgotten while they were go at the dramatics I'm about to write them up but imagine you were looking at the story I just told in three transactions and putting together the cash flow numbers well I said don't forget the original transaction the trading transaction we saw cash come in of affiliates or a very simple cash flow thing ten million of cash came in that was not berating cash inflow right so long up there in my investing sector we decided that was spending ten million on a new asset so the cash flow captured there would be ten million and not surprisingly I'm taking a bit of a shortcut here there'd be a description under this big bold heading saying something like purchase all fixed assets okay so it have a little nice little subheading but I'm just taking a shortcut to show the basic principles and we said that we paid off a million pound of outstanding debt so we presumably have a million-pound going out in the financing section described as something sensible like repayment of debt if you look that up in a typical published cash flow statement we call something sensible like that okay so actually overall ten million in ten million out that gives us a 1 million pound negative cash outflow they catch envelopes so the business is chewed up cash over this twelve month period can three simple transactions okay for anyone thinking just remind me what would that what would that look like in profit loss account terms why do I need to look at the cash flow statement why am i interested well if you were doing a running sort of profit and also count all right now we're not talking about profit loss accounts in this video particularly but if you were don't forget from my first transaction I build seventy million of sales you might remember that okay okay almost here people frankly whirring back through the video by build seventy million that would appear in the profit loss count sales transaction number one okay we decided that the asset I bought in the first year attracted a charge of just 1 million depreciation all right profit loss accounts are laid out slightly differently to cash flow statements so all I'm doing here is getting to the net result share different it could be and the third transaction we said had no profit loss now effect because it was simply writing a check to pay back debt there's no profit in that you're just clearing outstanding balance okay so nil so take a look at this in profit and loss account terms I'm showing a sixty nine million profit right now you'd have to agree even you haven't entirely followed by and you said there is quite a difference between the piece of paper that says sixty million not 69 million positive and a piece of paper a few pages behind it this is actually no the true picture for the year is 1 million negative which is right right they're both right it's just their stories told from a different perspective okay so how can invest and invest to use all this you're probably never going to build a cash flows techne your life so how can you use all this well let's finish the video with a handful of key questions to ask yourself if you were to pick up a cash flow statement all right so let's not worry about profit loss counts except that we've just seen that there's a big difference in the net result picking up the cash flow statement good questions to ask number one how different is the bottom line bigger or if it's very different you need to start doing some investigation why is the business of making profits and chewing up cash what's the story good place to start up here that's why it's heading number one is the operating cash flow positive personally if a business making negative operating cash flow why you choose up cash even just doing its day-to-day if it is let alone buying selling assets or the nail I'd steer clear right and if there's a big difference between firms operating cash flow and it's operating profits I want to know more that's not a trend that's sustainable ok number two investing cash flows what is the business buying and why is this money going out to pay for whole company is it money going out to pay for single assets are we replacing existing assets to survive or are we expanding the business so what are those cash flows okay and by the way for anyone who knows a little bit about accounting one way of getting a quick snapshot on whether you're talking about subsistence The Ecstatic expenditure or expanding the business is to compare the depreciation charge in the profit loss account with what's being spent on capex okay for anyone who doesn't get that test don't worry why it's not vitally important to this video thirdly investing cash flows what's going on down here is the business issuing shares is it buying back shares what's going on if the business is raising long-term financing its popping up in this financing section of the cash flow statement I want to know why what you don't want to see you for example is a mismatch you don't want to see a business raising long term sources of capital new shares or long term debt simply to keep itself afloat simply to fuel the loss making activities that are gobbling up all of this money is being raised that's not going you can't run a business in that basis that's not sustainable short term sources of finance go with short term problems long term sources of finance should be used here for new assets again not up here cash burn or some internet companies have been guilty in the past raising capital and is chewing it just to stay alive if you like not to invest long-term in their businesses okay so take a look at all three headings they are slightly different questions is the business chewing up cash this tastes activities is it investing and if so where is it investing okay replacement new assets and financing all right what sort of finance can you see coming in through the cash flow statement and where is it going quite hell's it being applied and those are the kind of questions that you can answer can cash flow statement but you'll get no clues on from just looking at profit and loss account so the message from this video is you don't need to be a cash flow statement expert yeah you should get right into the nitty-gritty as an investor but the three bold headings that hit you in the face my cash flow statement are well worth a quick look okay and if you want to test the story the directors want you to focus on in the profit or loss account there's no better way of doing it than rummaging around in this document

Channel: MoneyWeek

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Keywords: Cash, flow, statement, is, king, Why, cash, matters, What, investing, Mark-to-market, JP, Morgan, Chase, Portfolio, valuation, Fund, successful, investor, Investing, tips, Dividend, stocks/shares, Working, Cashflow, Overtrading, market, firms, profit, loss, trading, Bid, offer, spreads, MoneyWeek, Tutorial, Currency, bank, credit, 'stock, market', investments, tutorials, Trading, Stocks, Analysis, Trade, Tim, Bennett, Economy, whiteboard, white, board, explained, Financial, Bloomberg

Id: GkGdlgX3xYI

Length: 19min 51sec (1191 seconds)

Published: Thu Jun 07 2012