17. Cash Flow Statement Analysis

[Dave86ch]

Hello investors,

I published the latest article on the Value Investing blog

 

17. Cash Flow Statement Analysis
https://dscompounding.wordpress.com/2021/12/08/17-cash-flow-statement/

 

Accounting isn't easy to digest, I'm trying to convey the essential parts directly related to investing in great companies for the long term,  in order to fight the decrease in purchasing power caused by the rampant inflation.

This world is full of noise, everyone wants to carve out a new noise frequency.
In investing there are few things to know, but these few things must be communicated in a simple and concise way. 

This is what I'm trying to do.

"Collecting the dots. Then connecting them. And then sharing the connections with those around you. This is how a creative human works. Collecting, connecting, sharing."
A. Palmer

 

I just completed the series on Financial Statements
Here the link to the blog articles:

 

17. Cash Flow Statement Analysis
https://dscompounding.wordpress.com/2021/12/08/17-cash-flow-statement/

 

16. Balance Sheet Analysis
https://dscompounding.wordpress.com/2021/09/08/16-balance-sheet-analysis/

 

15. Income Statement Analysis
https://dscompounding.wordpress.com/2021/06/04/15-income-statement-analysis/

 

All the best,

Dave

 

Post Scriptum: The blog is meant for novices, my prospective on what I learned until now.

It's not the Holy Bible but rather my attempt to help who start the journey.

 

 

Edited December 10, 2021 by Dave86ch

[SharperDingaan]

You might want to rethink.

An accountant put together the financial statements, he/she had all the relevant facts, it is to a specific accounting standard, and the process is audited once/yr. Similar thing for Life Insurance actuary reports, and o/g Reserve Reports. But ......  the statement is only a snap-shot as at a point of time, and by itself - of limited use. Zero context.

 

Investors compare over multiple quarters for a reason, it's straightforward to move revenue and expenses between quarters, harder to do it between years, and over multiple years; 'patterns' become visible. Hard to bullshit, when the audience is looking at the most recent 20 consecutive quarters of cash flow statements, and related ratios. Investors also look at cash 'cause it erases arbitrage between accounting standards (USGAAP vs IFRS) - cash pays bills, not accrual driven income. The marketing folks look everywhere BUT cash - if you don't talk about it, it doesn't exist.

 

Life Insurance financials are driven from the Actuarial Report which sets the liabilities; assets and equity build around it, with cash as the plug. The changing cash flow statements hint at the evolving liability risk. Context.

 

Oil and Gas financials are driven from the Reserve Report, which typically sets the company growth rate. A mining or o/g gas company is in perpetual blow-down unless it can replace its assets. The Reserve Report typically determines the debt ceiling, and the remaining 12-month capital available for asset replacement - by either exploration, drilling, or acquisition. Context.  Reserve based lending (RBL) is the cheapest form of debt financing there is.

 

Point? There isn't much to understand about about a Statement of Cash Flow, it's all about the flow of cash, NOT cash as at a single point in time.

Sure, the marketing folks will hate you - but notice how many of them are poor. If they were as smart as claimed, shouldn't they mostly be rich? Context .

 

SD

 

[Dave86ch]

Hi, thanks for your comment.

My goal with this article is to highlight the most important figures in the Cash Flow Statement and extrapolate useful metrics and values as an introduction of the calculation of the FV.

I wrote 17 articles where I tried to create the mental frame to approach the analysis of the main components of the three statements.

The blog is readable as a book and it was meant to be a percourse not a single step, I also pointed out which type of business I want to buy&hold for the long term (focused on my circle of competence, this blog is a mental map for my investing journey).

In the next article I will introduce the extrapolation of the future figures analyzing past qualitative/quantitative performance and forecast the future based to the presence of a competitive advantage that protect/enhance the model that generated the past performance.

That said, thank you for the prospective I will think about it and if necessary I will make some change.

I prefer to be judged by the readers rather than by the market and consequently lose money because of a cognitive errors.

Edited December 10, 2021 by Dave86ch

[scorpioncapital]

would love to see a more in depth exploration of 'change in non-working capital' section. This is a poorly understood area of cash flow statements and can give clues to the quality of earnings . It often can cause substantial differences between the reality or fiction of some measures of free cash flow.

[Dave86ch]

4 hours ago, scorpioncapital said:

would love to see a more in depth exploration of 'change in non-working capital' section. This is a poorly understood area of cash flow statements and can give clues to the quality of earnings . It often can cause substantial differences between the reality or fiction of some measures of free cash flow.

Great suggestion, I will do it. Even if I found little material on this matter untill now.

[SharperDingaan]

4 hours ago, scorpioncapital said:

would love to see a more in depth exploration of 'change in non-working capital' section. This is a poorly understood area of cash flow statements and can give clues to the quality of earnings . It often can cause substantial differences between the reality or fiction of some measures of free cash flow.

 

It is also one of the more entertaining portions of an accounting lecture ..... lot of rogues and  manipulation in here!

Depreciation. Tax depreciation > book depreciation = deferred tax liability = zero interest loan = lower WACC = higher valuation. 

Depreciation:  Managing expectations High rates over high income periods to lower income & fund the jar, reverse during low income periods. Write down more aggressively than needed (bath tub), write up as you need an income boost. The controller maintains a pre-close spreadsheet for a reason ....

 

There is a reason why everybody looks at the Statement of Cash Flow ...

it's not JUST to see where the cash is coming from, and going to 

 

SD

  

[Dave86ch]

3 hours ago, SharperDingaan said:

 

It is also one of the more entertaining portions of an accounting lecture ..... lot of rogues and  manipulation in here!

Depreciation. Tax depreciation > book depreciation = deferred tax liability = zero interest loan = lower WACC = higher valuation. 

Depreciation:  Managing expectations High rates over high income periods to lower income & fund the jar, reverse during low income periods. Write down more aggressively than needed (bath tub), write up as you need an income boost. The controller maintains a pre-close spreadsheet for a reason ....

 

There is a reason why everybody looks at the Statement of Cash Flow ...

it's not JUST to see where the cash is coming from, and going to 

 

SD

  

I will do an in-depth on this topic in next articles, thanks for the ideas.

[LongHaul]

Financial Shenanigans by Howard Schilit was a really great book  on balance sheet/ cash flow analysis.  

Same stuff still happening today all over the world at some companies.  The auditors can't seem to catch anything - I view them as worthless for fraud detection.

[Dave86ch]

17 hours ago, LongHaul said:

Financial Shenanigans by Howard Schilit was a really great book  on balance sheet/ cash flow analysis.  

Same stuff still happening today all over the world at some companies.  The auditors can't seem to catch anything - I view them as worthless for fraud detection.

Yes, great book. I have already read it. Very insightful, Im planning to read it once a year, given my bad memory :D.

[vng510]

Revenue/COGS gives the % margin of profit

 

Shouldn't this be %margin profit = Gross Profit / Revenue?

[Dave86ch]

On 12/14/2021 at 8:41 PM, vng510 said:

Revenue/COGS gives the % margin of profit

 

Shouldn't this be %margin profit = Gross Profit / Revenue?

You are right! I hadn't noticed this serious mistake. Thank you very much ,  I corrected it. Im sorry but sometimes even when I reread the same thing 100x I don't see plain errors.