How does a cash flow statement work?
How do cash balance and cash flow relate to each other?
What is cash flow from operating activities, cash flow from investing activities, and
cash flow from financing activities?
You will find all of these explained in this Finance Storyteller video.
The cash flow statement is one of the three main financial statements.
As the cash flow statement explains how much cash has come in and gone out during a year,
and what the sources and uses of this cash flow were, you could see the cash flow statement
as an explanation of how the cash balance (one of the most important assets) has developed
between two balance sheets.
A useful metaphor is to see the cash balance as the water level in a bathtub
at a point in time.
Cash flow is how much cash has come in through the taps minus what flowed out during a period.
So if you check the water level in the bathtub at 9 PM and at 9:05 PM, then those are
two balances.
If the water level has risen during those five minutes, you have a net cash inflow.
If the water level dropped, you have a net cash outflow.
Cash balance...... Cash flow
Keep that bathtub metaphor in mind when you think about cash balance and cash flow.
Cash is king.
It is critical at every stage of a company's lifecycle.
When you open your own business, you need cash to get started.
You will need cash to grow and expand.
If a company runs out of cash to pay its bills, it's game over.
What you see in a cash flow statement should be a direct reflection of a company's strategy.
Is the company spending enough to build its unique and sustainable competitive advantage?
Are customers willing to pay for the products and services that the company supplies?
Is the company able to reward its investors for the risk they have taken,
by paying a dividend?
These and other questions can be answered by analyzing a cash flow statement.
Let's work through an example of a cash flow statement, more specifically the one reported
by oil and gas company Shell in its fourth quarter 2016 earnings release.
A quick reminder before we go there: this video is for educational purposes, none of
the comments in this video should be interpreted as investment advice.
All numbers and graphs about publicly listed companies come direct from the earnings release
and other disclosures by that company.
Shell's cash balance at the end of 2012 was $18.6 billion dollar.
At the end of 2013, the cash balance was $9.7 billion dollar.
The cash flow during 2013 was therefore a negative $8.9 billion, as the cash balance
has decreased versus the prior year end.
At the end of 2014, the cash balance was $21.6 billion dollar.
The cash flow during 2014 was therefore a positive $11.9 billion,
as the cash balance increased.
At the end of 2015, the cash balance was $31.8 billion dollar, due to a positive cash flow
during the year of $10.2 billion.
At the end of 2016, the cash balance was $19.1 billion dollar, due to a net cash outflow
during the year of $12.7 billion dollar.
It's nice to have the total numbers of the cash balance as well as the total net cash
flow, but it doesn't tell us much yet about what goes on inside the company.
To get a more meaningful look, we have to drill a level deeper into cash flow.
That's why a cash flow statement is split into three sections.
The first section will have the word "Operating" in it, the second "Investing", the third "Financing".
Many companies will call the first section "Cash From Operating Activities" or CFOA,
or a variation on that wording like "Cash Flow From Operations".
Cash From Operating Activities is roughly the cash inflow from customers paying the
company minus the cash outflow of the company paying for purchases from suppliers,
minus the cash outflow of salaries paid to employees, and minus the cash outflow of taxes
paid to governments.
For most mature companies in good health, the cash flow from operating activities is
a net cash inflow.
The second section is often called "Cash From Investing Activities",
or a variation on that wording.
This is where Capital Expenditures (a cash outflow), acquisitions (a cash outflow) and
divestments (a cash inflow) are recorded.
Cash From Investing Activities tends to be a net cash outflow for most companies
in most years.
The third section is often called "Cash From Financing Activities",
or a variation on that wording.
This one can go either way: a net cash inflow or a net cash outflow.
Does the company need money and attract new debt to finance itself?
Then there will be a cash inflow.
Does the company have a lot of cash on its balance sheet and no plans to put that cash
to any productive use?
Then the company might be paying a dividend to shareholders, which is a cash outflow.
Let's look at the three categories (operating, investing and financing) for Shell!
Shell has provided a long term overview of 2010 through 2014 to show how the
various types of cash flow are related.
Shell generated a very substantial cash flow from operating activities, of up to $45 billion
in 2014.
What does Shell subsequently do with this cash inflow?
It pays out dividends to shareholders and buys back shares, up to $13 billion in 2014
in total, and has very large CapEx (or capital expenditures) with a peak of
$40 billion in 2013.
By keeping a healthy balance between cash inflow from operating activities, and the
cash outflows from financing activities (dividends) and investing activities (CapEx), Shell
at the same time was able to keep its balance sheet healthy.
However, times have changed dramatically in the oil industry.
In Shell's case, every change of $10 in the oil price impacts cash flow by $3B - $3.5B,
and as you can see in this graph, the oil price has dropped significantly from an average
of $100 per barrel in 2014!
If you are interested in a more in-depth look at the similarities between two very capital-intensive
industries, please check the blog article on my website, which I will link to below
in the description of the video.
So how did Shell do on cash balance and cash flow in the most recent financial year it
has reported on?
Shell started 2016 with $31.8 billion dollar in cash, and ended with $19.1 billion dollar.
The net cash outflow during the year was $12.7 billion dollar, as the amount in uses of cash
(on the right of the graph) exceeded the amount in sources of cash (on the left).
The continued low oil price has led to the lowest cash inflow from operations
in many years.
The CapEx cash outflow is also much lower than before, so that partially offsets it.
An "unusual item" in 2016 was the large acquisition of BG Group, or British Gas, which changes
the business portfolio and strategic direction of Shell.
Here is that very same overview in numbers.
The cash opening balance of 31.8 is at the top, and the closing balance of 19.1
at the bottom.
The numbers in the middle are the cash flow line items.
Cash outflows are shown as negatives, between round brackets or parentheses.
This table is from Shell's earnings release presentation, there is more detail in the
supplemental financial disclosures published on the same day.
On a cash flow statement, the first section is cash flow from operating activities,
the middle section cash flow from investing activities, and the bottom section
cash flow from financing activities.
Understanding cash flow is a key element of "getting the picture" of a company.
As an investor, analyst, employee or supplier, it is advisable to understand both
the actual numbers of past years, as well as the intent going forward.
At Shell, corporate strategy and the cash flow statement are highly interlinked.
Shell's cash priorities are debt reduction, dividends, share buybacks and capital investment.
The drivers to deliver on those priorities are divestments, reducing capital investment,
reducing operating costs, and delivering new projects.
If we zoom in on the second lever of these four, capital investment,
Shell shows us this picture.
After the significant CapEx reduction in recent years, Shell intends to stabilize
the annual CapEx in the $25-$30 billion range.
More detail on the specifics of Shell's projects under construction are available in the
Q4 earnings release of Shell.
I hope this cash flow statement explanation and cash flow statement example were useful!
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