if you buy individual stocks you must learn how to read a cash flow statement however a
cash flow statement can be really intimidating to look at especially if you don't know what to
look for in this video we'll take you through a cash flow statement line by line and teach
you how to read a cashless statement like a pro my name is Brian Feroldi and my name is Brian Stoffel
thanks to Quartr for sponsoring today's video brian let's start with the most obvious question
what is a cashless statement a cash flow statement simply tells you about the movement of cash
in and out of a company over a period of time now you might be wondering isn't that the same thing
as an income statement well an income statement is governed by accounting rules but a cash flow
statement is governed by the amount of cash that goes in and out of your accounts and for some
people that is a more reliable indicator of how business is doing than an income statement which
is governed by rules which can be difficult to understand one way to think about it is an income
statement is kind of like an opinion of the cash movements of a company and a cash flow statement
is the actual cash movement to those companies in some cases those two things can be miles apart now
one key thing to know about a cash flow statement is like an income statement and a balance sheet
not every cash flow statement will look the same from company to company management teams do get a
little bit of leeway with how they organize and label things however all cash flow statements
follow this rough guideline and it's broken down into three main parts on the top of the cash flow
statement is the company's operating activities which is all the cash movement in and out of a
business from just normal day-to-day operations the next section refers to investing activities
and this accounts for cash that the company either generates or spends while investing into itself
final section of the cash flow statement is called financing activities and this tracks the movement
of cash related to debt stock or dividends now at the end of the cash flow statement the company is
going to represent the net changes in cash from all the activities combined and it's going to add
that or subtract that from the cash at the start of the period and show you the cash at the end
of the period we actually think it makes sense to reorder these so that it looks something like this
you can think of it as the cash the company starts with plus or minus the cash the company makes or
spends during that period and the end result is the amount of cash that company ends with so
let's go ahead and break down each of these three sections one by one and we'll start with operating
activities now the very first line item of a cash flow statement is net income which is the
bottom line item of the income statement the next section accounts for non-cash charges regarding
the business now what are non-cash charges a couple examples can be depreciation which is a
value of an asset decreasing over time an example could be your car you know that the longer that
you have your car the less valuable it is and you account for that in the income statement however
there's no cash leaving your bank account as your car ages and so that cash is then pushed back in
the cash flow statement another type of non-cash charge is amortization which is the process of
writing down the value of a loan or an intangible asset over time that also is a non-cash charge
so that non-cash charge needs to be added back in since cash didn't leave the company's balance
sheet to pay for that expense and finally we have stock based compensation we see this a lot
especially with young tech companies that decide to pay their employees with equity or stocks in
the company they hold by issuing that stock their company is not actually losing money it
is not paying it out of its bank account so in the cash flow statement the value of those stock based
compensations gets added back in the next expense is changes in working capital what does that mean
well there's three broad categories of working capital the first is accounts receivable this is
money that a company expects to collect from its customer but hasn't yet collected so if a company
makes a sale to another customer on credit but it hasn't yet received the cash yet that
increases the company's account receivable balance the flip side of that coin is accounts payable and
that is money that you expect to pay but haven't yet paid the higher that gets the higher your
cash balance is because you're holding on to it while you wait to pay for the services or goods
you've already received the final type of working capital is just inventory this is the value of
all the products that you have in your warehouse somewhere that haven't yet been sold the higher
that number goes the lower your cash balance is conversely if you sell off inventory that
increases your cash balance after accounting for all these non-cash charges and changes in working
capital what you're left with is operating cash flow or the amount of cash being brought in from
running your normal daily business next let's take a look at investing activities the first line item
in investing activities is an important one it's called capital expenditures related to property
plant and equipment this is more commonly called capex and this is the funds that a company uses to
buy upgrade or maintain its physical assets and that can include property machinery buildings
technology or equipment etc capital expanders is a key number for investors to know because it helps
us calculate free cash flow formula for that is very simple operating cash flow which is the
bottom line from the operating activities minus capital expenditures which is the top line from
investing activities now capital expenditures is an important number for investors to focus on
the reason is by using capital expenditures and operating cash flow we can do some quick math
to figure out what the company's free cash flow is during a time period to find that we simply
start by looking at the operating cash flow which is the bottom number from the operating
activities subtracting out capital expenditures or capex which is the top number from the investing
tactics the difference between those two is a company's free cash flow during that period and
going back to the earlier metaphor we used a lot of people think that net income is how much profit
a company brings in but there are some investors that think that free cash flow is a more accurate
figure because it is a fact that that much cash has entered the company's coffers for example
brian when we and you are breaking down a business we pay much more attention to free cash flow than
we do net income exactly let's continue going down to the next line item which is acquisitions
this is pretty self-explanatory an acquisition is when you pay money or stock to acquire a company
and almost always this is going to be negative in terms of cash flow because you're paying cash
out to acquire the company the finite line item in investing activities is a positive
number and that is the proceeds from sales of investments that the company previously made
so if it's sold out equipment that it previously bought or real estate that it previously bought
that would be a cash inflow so that would be a positive number when all of that is said and done
we've got the next section complete and we know how much money was gained or lost as a result of
investing activities before we finish the catfish statement we want to give a shout out to today's
sponsor quarter with quarter investors get frictionless access to conference calls
investor presentations transcripts and earnings reports from markets all around the world
straight to your pocket at no cost quarters mission is to change the way that people look
at investor relations and to create a completely new bridge between companies and its stakeholders
i love using quarter because it's a free easy way for me to listen in on all my favorite companies
and conference calls while i'm on the go if you're interested in giving corner a try visit
the app store of your choice and download quarter today for free that's spelled quarter q-u-a-r-t-r
thanks quarter for sponsoring this video final section is a company's financing activities
this is the cash flow of a business that focuses on a company raising capital and paying it back
to investors through the capital markets the first section we have is regarding debt now if a company
takes on debt normally that's seen as a bad thing but in a cash flow statement that means that
more money is actually going into that company's coffers if it pays debt back that's considered a
good thing but in the cash flow statement that lowers the amount of cash that a company has
because it's leaving its bank account to be paid out next would be any changes in cash due to the
issuing or buying back of stock this can be a positive number if a company is creating shares
and selling them or a negative number if the company is buying back shares and retiring them
and finally we have dividends a company likes to reward its shareholders by paying out its excess
free cash flow in the form of dividends if it pays a dividend that's usually considered a good thing
by investors but for the cash flow statement it is a negative because it reduces the amount of
cash that a company has add all those activities together and you get the net changes in cash at
a company due to financing activities all right brian time to run through a very simple example
let's go back to the coffee stand that you own and show how that you create a cash flow statement
well we'll start with operating activities from the last video we know that net income came in
at fifteen hundred dollars but let's look at the non-cash charges that the company might have had
the first one is depreciation and we do have to account for that because i bought an expensive
coffee roaster for this stand and it's about 150 that came out of the net income statement but gets
pushed back in because we didn't actually pay money during the year because of it if
we look at amortization there were no costs there if we look at stock based compensation
we did not decide to pay my daughter through stock based compensation so we can add in 150 there next
would be changes in working capital right so here we had a hundred dollars that hadn't been paid
by the end of the year for a large order of roasted coffee beans so i accounted for
that as a sale but in terms of cash flow i had not yet received that money so we're going to
lose money there when it comes to accounts payable there were no bills left unpaid by
us so there's nothing to add back in and when we look at inventory we had about 500 worth of unsold
beans at the end of the season which means that we'll take out 500 from the cash flow statement
so in your case brian your accounts receivable and your inventory were actually consumers of cash
and that reduced your cash balance by about six hundred dollars so when we add all that together
brian your company generated about a thousand and fifty dollars in operating cash flow last
year that's a remarkably different number than the 1500 in net income that you booked let's
move on to the next section investing activities this should be pretty simple for a simple coffee
stand and we'll start with capital expenditures on that line item we spent about two hundred dollars
because we had to get a new tent to put over our coffee stand so that results in a net 200
dollar charge to your cash so now we have enough data to show your free cash flow for the period
so again we look at operating cash flow which was positive one thousand fifty dollars subtract that
two hundred dollars in capital expenditures that you spent on the tent so that gives us a free
cash flow of the period of eight hundred and fifty dollars that's only about 60 percent of the 1500
in net income that you reported that's correct and it really highlights how important it is to look
at both the net income and the cash flow statement all right let's keep moving on did you have any
acquisitions during the time unsurprisingly we didn't acquire any other rival coffee stands at
the farmer's market okay did you have any proceeds from selling any investments no we did not make
any investments as a coffee stand so that gave us net cash using investing activities of negative
two hundred dollars so for the financing section we'll go through it really quickly because it's
silly to talk about it for a non-publicly traded company we didn't pay any debt or repay debt or
purchase stock or pay dividends or anything like that so zero dollars for financing activities
but if we look at the entirety of the cash flow statement here's what we see
you started out with fifteen hundred dollars in net income you had a hundred fifty dollars in
positive gain due to non-cash charges you had six hundred dollars in negative cash due to changes in
working capital and that gave you operating cash flow of one thousand and fifty dollars
that's right and for investing activities we said that we spent about two hundred dollars on the
tents we pulled that out for capex but we made no acquisitions and there were no proceeds from
the sale of investments so we spent two hundred dollars in investing activities and as you sent
you spent zero on debt zero on stock zero on dividends so that gives you a net cash using
the finance activities of zero so if we add all that together at the beginning of the period you
started out with two thousand nine hundred dollars in your business you had changes in cash flow of
positive eight hundred and fifty dollars and that left you with three thousand seven hundred and
fifty dollars at the end of the period all right so now that we've got a very simple example out
of the way let's dig a little deeper into a real publicly traded company that many are familiar
with called netflix netflix is my favorite example to showcase is the difference between net income
and free cash flow because they are miles apart if you want to find netflix's cash flow statements
simply go to your favorite search engine and type in the company name and investor relations in
this case netflix investor relations when the page comes up you should be able to find somewhere that
has the company's financial statements which you see pointed out right here you can also sometimes
find this information by looking at the most recent earnings report some companies do provide
a cash flow statement with their earnings release otherwise it would be in the most recent 10q which
is a quarterly report or a 10k if it's an annual report all right so one of the reasons we picked
out netflix is because as brian said there are huge divergences in net income and free cash flow
in 2019 for example netflix reported net income of 1.9 billion dollars sounds pretty good however
if we look at their free cash flow they had a loss of 3.1 billion dollars that's a difference of five
billion dollars this isn't chump change so what's going on here let's find out so here's what the
company's statement of cash flow looks like let's start by zooming in on the operating activities we
see that the company reported 1.9 billion dollars in net income sounds pretty good but as we make
our way down the cash flow statement we actually saw that the company spent almost 14 billion
dollars on new content so that new content would be like in this case the final season of orange is
the new black or whatever new movie or tv show you saw that was produced in 2019 that's a lot of new
content netflix had to pay for all that content up front because actors directors set designers all
want to be paid while the content is being created however at the same time the company gets to add
back some things because of amortization in other words all the money that they paid before
was taken out at some point to be amortized but really that cash was not leaving the company's
statement so it had 9.2 billion dollars in the amortization of their assets what does that mean
it means that in the net income statement they accounted for the first five or six seasons of
orange is the new black well they weren't actually losing any money in 2019 because of that because
they'd already paid it so all those other seasons you push the cash back in that you subtracted out
in the net income statement there's several other line items in here as you can see but we'll skip
over and we'll just focus on the big ones another big positive contributor to operating cash flow
with stock-based compensation during the year the company had more than 400 million dollars in
stock-based compensation expense however that was an expense that was a non-cash charge as a result
we have to add that back into the company's cash balance what's the effect of all this well the
effect as we've already shown you is that while it had 1.9 billion in net income if we look at
the cash generated or lost from operations it was about a 2.9 billion dollar loss and again almost
all of that is accounted for in the depreciation or the change in those content liabilities
and the amortization of their previous liabilities but remember that's not free cash flow to figure
out the company's free cash flow we also have to account for capital expenditures which is
the top line item in the investing activities so if we check out that segment which is the next
thing in the cash flow statement we saw that the company spent 253 million dollars on the purchase
of property plant and equipment now we have enough information to figure out a company's free cash
flow so the netcast use and operating activities was negative 2.9 billion and the amount of money
that it spent on capital expenditures which is property plant equipment was 253 million you
add those two numbers together and in that case we get free cash flow of negative 3.1 billion dollars
during the period finally let's look at netflix's financing activities which are actually very
important because you might be wondering how can netflix afford to run their business when they're
losing 3.1 billion dollars here's how you see that proceeds from the issuance of debt is 4.5
billion dollars now normally we think of taking on debt as a bad thing and in the future it can
be a bad thing but in terms of again just cash being put in the bank because netflix took on
the debt it was able to add 4.5 billion dollars to its bank account so if you look at all of
that together during the year 2019 netflix's cash balance actually went up by 1.2 billion dollars
even though that was entirely due to the issuance of debt so the company started the year with 3.8
billion dollars and it ended the year with 5 billion dollars if you were just looking at
the net income statement you would say netflix is wildly profitable but by looking at the cash flow
statement you can see that the company is actually burning capital and relying heavily on issuance of
debt to fund itself so what does all of this mean in plain english if you don't have an accounting
degree well in its simplest form netflix is saying we're spending boatloads of cash right now
that's the cash flow statement but then they're adding on to say but here's why we think that's
okay the opinion the income statement obviously that has worked out quite well for netflix and
it shows the value of the income statement and you need to be able to balance what you see in
both statements to make an investment decision that fits your portfolio now i was an investor in
netflix during this entire time period and today netflix is starting to actually generate cash flow
but there's no better example in my mind i've shown the importance in the difference
between the income statement and the cash flow statement than looking at netflix financials
well we hope this video was useful to you if you want to watch our other detailed videos on
the income statement and the balance sheet click the links that you see on your screen brian's out