Cash Flows Explained

this video is sponsored by wall mine go

to wall main comm saj plain bagel to

create your free account in warren

buffett's latest letter to shareholders

he provided a pretty blunt criticism of

accounting earnings numbers you see well

his company berkshire hathaway had made

twenty four point eight billion dollars

in operating profit in 2018 the company

only reported earnings of four billion

dollars primarily the result of a loss

in unrealized capital gains so even

though the business had effectively made

twenty four point eight billion dollars

they had to report a small earnings

number because of the market value of

some of their investments went down this

is just one example of the noise

included in a company's net income

number found on their income statement

it's why many investors prefer to look

at a company's cash flow statement when

analyzing performance you see a

company's ability to generate cash is an

important factor to consider when

researching an investment idea and

looking at a firm's cash flows can clear

whether a business is actually making

money or if they're simply abusing

accounting rules to inflate their

earnings number so let's go over cash

flow statements and why cash is king on

today's plane dangle

a cash-flow simply refers to cash that a

company has paid out or received in

other words it's any revenue gain

expense or payment the company has

actually realized that has actually

impacted their bank account in a perfect

world one would expect that cash flows

would be identical to the revenue

expenses listed on the income statement

but this is rarely the case gains and

losses on the income statement can be

non-cash in sometimes a business may

accrue expenses or revenues for which

cash has yet to change hands for example

a company may have a bill they need to

pay next year and while this would be

recognized immediately on their income

statement the cash flow is only

recognized once the money actually

leaves the company's bank account

this makes cash flows a lot more

straightforward than net income if a

company pays out or receives cash it's

including cash flow if not it isn't and

many analysts give a lot more waiting to

company's cash flows than their earnings

Amazon is a great example of this in

2014 the company actually reported

negative earnings meaning that according

to their income statement they were

losing money in reality however the firm

achieved record operating cash flows and

added 5.9 billion dollars of cash to

their balance sheet but obviously where

this cash is coming from is important

here in increasing cash is great but we

need to know if the amount is coming

from an increase in sales or a bank loan

that the company took out for this

reason the cash flow statement groups

its cash flows under three different

classifications the first of which is

the cash from operating activities by

far the most important grouping this

amount is a fundamental measure of the

amount of money of business has made

from their operations and oftentimes

when people are simply referring to a

company's cash flows they're actually

referencing CFO the amount includes cash

received from sales minus cash paid to

suppliers and employees as well as

interest paid on debt and the taxes paid

to the government it's basically a

measure of a company's operating profit

and like any other profit number a high

and growing CFO likely signifies a

growing business while a shrinking CFO

signifies a shrinking business worse yet

a negative CFO means that a firm's

operations are actual

losing money and if it doesn't improve

well accompany is almost certain to

eventually go out of business the second

classification is cash from investing

activities this amount includes anything

that involves the purchase or sale of

longer-term assets such as property

plant or equipment it's essentially any

money that has been spent to grow the

business maintain the firm's current

assets acquire other companies or invest

in different securities for example

Klain beigel Co would include the

purchase of a company delivery van the

acquisition of a competitor and the

purchase of money market investments

under its CFI cash flows from investing

are typically negative because they

often involve a company investing money

into its growth or at the very least

into maintaining their business but it

can occasionally be positive if a

company is receiving cash from its

investments or when a firm is actually

selling its assets the final cash flow

is cash from financing activities this

is where you will find the amount of

money the company has raised through

share issuances bond issuances or other

forms of debt if a company takes out a

loan the money they receive will show up

here as a positive cash flow this is

also where you would deduct share

buybacks dividend payments and

accompanies principal repayments on

their debt level so a positive cff means

that a business is raising money

possibly to grow its operations and a

negative cff means that a business is

paying money out either to its

shareholders in the form of share

buybacks and dividends or to its

creditors in the form of principal

repayments which will lower its debt

level so those are the three types of

cash flows and when you net them

together you end up with the company's

net change in cash the amount by which

the firm's cash balance changes in a

given year there's also a fourth

honorary member of the cashflow family

known as free cash flow or SCF and it's

loved among value investors free cash

flow is simply equal to company's ocf

their operating cash flow minus capital

expenditures or the money from CFI that

the company spends on longer term assets

like company vehicles or buildings this

number is important because it

essentially shows how much money a

company has after covering its

obligations it's money that is free

any commitment it can be used by the

firm to pay dividends buy back shares

pay down debt or pursue acquisitions and

it's a profit measure that gets a lot of

attention from analysts a company with

strong free cash flows is usually able

to self fund growth initiatives without

taking on extra debt whereas a firm that

has consistently negative free cash flow

is likely spending more money than its

generating and will eventually need to

raise funds so those are cash flows in a

nutshell but perhaps you don't fully

understand why analysts give the measure

so much merit after all all the

confusing rules and assumptions in net

income are meant to reflect a company's

financial situation is that not good


well the income statement is useful to

an extent but cash flows offer a more

complete picture and can provide

valuable insights into the quality of a

company's earnings or how sustainable

they are let's go through an example

imagine you have two bagel companies

plain bagel CO and sesame sands let's

assume that the companies have identical

balance sheets and for 2018 they both

record earnings of 10 million dollars on

in their income statement one might

assume that these companies have similar

financial strength but even with these

similarities the two can vary

drastically which we can see by looking

at their cash flow statements for

example on plain bagel coast cash flow

statement you can see that the firm has

a high CFO that is able to fund its CFI

and actually returns money to its

shareholders and creditors in its cff on

the other hand sesame sands has a lower

CFO and a steep CFI so they're spending

a lot more money than they're making

from their operations and they are

taking out debt to finance the spending

which is shown in their CFF so even

though the companies have the same

earnings number plane bago co appears to

be in stronger financial situation it

goes to show why it's important to

understand both the company's

profitability and their cash flows

companies with higher cash flows tend to

have more reliable business models and

have fewer problems when it comes to

funding their business cash flows also

provide some insight into a firm's

earnings quality if a business is

reporting too high profits but they have

a low or negative operating cash flow

such as with sesame sands

then it's possible that they are

inflating their bottom line now the

nature of a company's cash flows can

vary drastically based on the industry

they operate within and there are

different rules for things like

interests and lease payments depending

on specific factors but even at a high

level with this basic understanding you

can learn quite a bit about a firm's

financial health just by looking at

their aggregate cash flows so next time

you look at a company make sure to check

out their cash flow statements to see

how each of the three numbers Pass flows

from operations investing and financing

have changed over time also be sure to

compare a company's cash flow to their

earnings if the two are close to one

another or if CFO is higher than net

income then the company probably has

higher earnings quality looking at free

cash flow will additionally show you

whether a company has money to spare or

if they are spending more than they are

generating from their business net

income can give you a quick rundown on a

company's performance in a given year

but for the full picture it's better to

count the cash with that said we're at a

time if you liked this video make sure

to hit the like button and if you like

we're doing here make sure to subscribe

did the bell icon if you want

notifications about future videos if you

have any feedback or topics you want me

to cover in a future video leave a

comment down below for the plain bagel

my name is Richard coffin thanks for

joining me today this video is sponsored

by wall mine if you're someone who

researches your own investment ideas or

if you like to monitor how your personal

investments are doing what mine is a

great tool for retail and professional

investors alike that makes researching

companies and keeping a pulse on the

markets easy it's got a pretty intuitive

and user-friendly interface and a lot of

Handy tools including a heatmap insider

trading information a stock screener and

even a portfolio tracking tool that you

can use for your personal holdings

probably the biggest difference between

this site and other pages like Yahoo

Finance and Morningstar though is its

simplicity when you search a company we

are brought to a profile that has all of

its information in one spot you'll find

their finances Trading multiples recent

headlines filings and a bunch of other

details all in one page making it very

easy to quickly get an overview of the

ticker you can use the website for free

and if you really like the service there

are options available to upgrade your

account make sure to use the following

URL or the link in the

down below to create your account and

let them know I sent either way if you

find yourself struggling to get the

information you need about the companies

you're researching or you simply want a

user-friendly tool to track your

positions I encourage you to check out

wall mine