Let's start to conclude here.
Alright well, Dave, you told us all the things that could go wrong.
How can we read this cash flow statement with intelligence?
Okay well, let's conclude by focusing on a few key points, alright?
Alright, number one, you need to analyze the cash flow statement in conjunction with the
balance sheet, and the income statement.
Do you remember the first time we were together?
I compared it to the judicial, executive, and legislative branch, and how those need
to provide checks, and balances, okay?
Well it's that same way.
Look at this document camera, okay?
You've got the balance sheet.
You've got the income statement, and you've got your cash flow statement, right?
Be wary of companies that say "Hey, take a look at our balance sheet, and our income
statement.
Man, those look good don't they?" and you go "What's under your hand?"
"Nope, don't worry about what's under my hand.
Take a look here.
Man, isn't that sweet?"
or sometimes they say this "Look at that!"
now most of the time, that doesn't work, because everybody wants to see the income statement.
Oh do you have a good bottom line?
Do you have a positive bottom line?
Okay?
So a lot of bankers will do this "Oh, got a good looking income statement, good looking
cash flow statement.
Boy, you need some more money?
We'll loan it too you."
"What's your balance sheet look like?'
"Well don't worry about that.
Look at these!
Whew!
Those look pretty!"
no, you need to look at the whole picture, okay?
Because if management is trying to do something that misrepresents themselves, a lot of times,
it will show up on one of the other statements, okay?
Now The United States recently went through a huge credit crisis, where we loaned a lot
of money out to people who will never be able to pay it back.
It was largely due to people loaning money to businesses that should never have money
loaned to them.
Now you might think that somebody who makes hundreds of thousands of dollars is very adept
at looking at financial statements, and they're not, always.
They've become more adept, but you need to be able to look at these three in conjunction
with each other.
That's the first point I wanted to emphasize, okay?
What's the next one?
Focus on trends in the data.
Focus on trends in the data, okay?
Here's another thing that bankers do.
I don't mean to beat up on bankers; There are some good ones, but there's also some
that all they do is they get your income statement, they look to see if the bottom line is positive,
and if it is, they might look at last year's.
Positive net income, positive net income, sounds like you're doing great, and that's
the extent, and they put it in the folder.
What I'm saying here is, we need to focus on trends in the data, okay?
Let me give you an example, okay?
Let me give you an example.
Let's say, and some people do this, they will graph, over time, they will graph how much
they weigh, okay?
Now let's say this is over a three or four year period of time, okay?
And you know when you go to the doctor, they weigh you every time, don't they?
They're doing this.
But let's say someone's weight over three or four years is doing this, okay?
Well they're clearly gaining some weight, are they not?
Well here's the problem, a lot of people, they don't ever look at any trends, they look
at this year, and last year, and they'll say "Oh, that doesn't look so bad.
Oh that doesn't looks so bad.
Yeah maybe a little bit" you see what I'm saying?
"Yeah it doesn't look so bad."
Oh look, you actually lost some weight.
You're doing great.
Well let's look at the trend here, okay?
That's when you see some very powerful metrics, okay?
The example I always use is this, okay?
I have an 18 year old son, and we have a photo album, and every year we put his school picture
in there, okay?
Here's the kindergarten.
The next page is his first grade, second grade, third grade, fourth grade, clear up to now,
his senior year, right?
If I take any of those pictures that are by each other, he doesn't look that different,
does he?
Just maybe a little, but by golly, if I compare his kindergarten picture to his senior year
picture, that's massive, isn't it?
That's looking at a twelve year trend, instead of a two year trend, you with me?
Financial statements are only prepared this year, and last year, that's not enough of
a trend.
You with me?
Okay, what else should we do?
Well, we need to use appropriate benchmarks when available.
Do you know what a benchmark is?
What I mean in this case is like, are there industry averages out there?
Okay?
Are there industry averages?
Now I didn't go into some of the metrics that are used in cash flow statements.
There's different methods like free cash flow, or cash flow from operations divided by total
assets, or average assets.
These are different metrics that you can trend over time, okay?
And sometimes you can calculate that, and compare it to benchmarks.
One meaningful benchmark is your own previous data, but sometimes they'll have industry
averages, and trade publications, and things like that, okay?
Alright, what's another point here?
Look for large swings when available, or look for large swings in balance sheet accounts,
in the operating section, okay?
What do I mean by that?
Well I'm going to take you way back to one of the first ones that we did, okay?
And that was OTW, okay?
This is OTW.
Well this is a really large swing.
An increase in inventory of 112,500.
That is a big part of this positive, cash flows from operating activities is it not?
That is what I am talking about.
Look for big swings in balance sheet accounts.
Is it good to have a huge increase in inventory?
What does that often mean?
It means nobody is buying your inventory, correct?
So you need to be careful.
You need to be wary, okay?
Not each item is equal either, alright?
Remember, the focus should be on sustainable cash flows, sustainable cash flows, are you
with me?
Can it be repeated?
Okay?
Now we're going to do one more thing before I'm done with these slides, but I want to
point out that this is a great book.
It's called Financial Shenanigans How to Detect Accounting Gimmicks & Fraud in Financial Reports.
This is a book that I have read, and I certainly have used.
There's things I've learned, and things I've learned, and things that I've talk about,
no doubt, that came from this book, okay?
So I'm, you know, I want to make sure that you're aware that this book exists.
This is a very easy to read book.
It's not written in accounting legalese.
It's very interesting, okay?
But this is one of the best books that I've ever read that taught me how to understand
a cash flow statement, okay?
So I want you to be aware of that, alright?
Okay, one last thing, a couple last things I want to do real quick, is I want to look
again at this Rosenow, remember when we did that?
I want you to see that this company doesn't look so hot.
This is the cash flow statement you prepared for today.
Look at that cash used in operating activities, well again, they're operating activities,
you would hope, would not be a net drain on cash, correct?
What else is in there?
Well there's an increase in accounts receivable.
Well, are people paying us slower?
I don't know we might need to investigate that.
We have an increase in inventory, and that stands out.
Remember when I talked about large swings in balance sheet accounts?
For the size of this company, whoops!
Wrong line, for the size of this company that should stand out.
Why is our inventory increasing so much?
Are people not wanting what we're selling anymore?
That could be a problem for future periods, could it not?
Okay, we bought some equipment.
We issued some stock.
It almost looks like- I mean look how bad our decreasing cash would be if wouldn't have
issued that stock.
It would be negative 11,150 if we would not have issued stock, and sold ownership at our
own company, and let me tell you, a negative 11,000 drop when you're talking about a cash
balance of that amount, that is huge, is it not?
Holy smokes!
It would have gone down from 30,000 to about 19,000.
That's about a forty percent, forty five percent decrease in cash, but we sold some stock,
okay?
Maybe to try to, you know, save ourselves a little bit, but I want you to know, with
your new analytical skills, can you look at this and say "Hmm, there's some concerns here."
You with me?
Alright, any questions on that guys?
Alright, well if there's no questions that is pretty much the end, okay?
Now for those of you who are watching this, more than likely, there are some other things
on this website contained in the shell of this class that you can do, and those things
I'll probably not lecture in a setting like this, but I will be talking through like a
Camtasia PowerPoint, or something like that, but that is pretty much it.
Is there any other questions that you guys have?
Do you feel like you understand the cash flow statement better than you did two weeks ago?
Okay, like I said, you will use this a lot in life, okay?
And we just touched on the most elementary concepts of analysis of a cash flow statement,
but as you go on in your business, and your educational careers, hopefully you'll get
more adept at that.
The book that I referred to is a great start, alright?
Any questions?
Alright guys, thanks a lot, and we'll see you later.