NSE #15: The Cash Flow Statement and Notes

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Last week, I explained the Income Statement and Balance Sheet. Today, I will be explaining the Cash Flow Statement. Then I'll talk about Notes (also known as Financial notes, the last part of a Financial/Annual Report). I'll be skipping the Statement of Changes in Shareholders Equity. 

The Cash Flow Statement shows the actual cash inflow and outflow of the company. I like to invest only in companies that have excellent cash flows: More money is coming in than is going out. There will be years when more money will go out than that come in -- when the company buys new capital assets (Equipment, Building and/or Plants). The one thing I avoid is a company that is always borrowing, even to pay dividends.

The Cash Flow Statement has 3 major categories:

  • Cash Flow from Operating Activities: This is, perhaps, the most important category. It shows how much money was collected from the customers and how much was spent on the core business/operations. If a company is spending more on its operations than it's getting from Sales, then there's a big problem. And that's what I make sure is not happening in companies I'm considering for investment.
  • Cash Flow from Investing Activities: This shows the cash generated by sale of company assets and cash spent on buying new assets. The net is usually negative, because companies spend more buying new assets than they gain from selling old assets (salvage value).
  • Cash Flow from Financing Activities: This shows cash that came in through financing activities -- taking a loan from a bank, selling bonds, rights issue, e.t.c. And it shows cash that was spent on servicing loans, repaying loans and paying dividends.
Often as the last line, Cash Flow Statements shows you how much cash the company has at a specified date. I like to see big positive numbers here. But it's not a rule.

Finally, Financial Notes.
Notes are additional information provided about entries in the Financial Statements. They explain the reporting standard used, and how the transactions were recorded and (all) things you need to know about the entries in the statements. 

Once I'm happy with a company's numbers, I take time out to read the last Annual Report cover to cover, paying attention to the Notes. If there's no IED detected, I begin calculating the maximum price I'm willing to pay for the company's shares.


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