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4 Tricks To Read A Cashflow Statement

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Don’t Listen To Me, But Please, Hear Me Out: # 13

July 21, 2020

Over the past 2 weeks, I showed you how to quickly check 3-4 items in an Income Statement and a Balance Sheet. The last report we will look at is the Cashflow (CF) Statement. 

Financial Statements

To Recap, there are 3 main statements:

  1. Income Statement (IS): Look at Revenue, Cost of Goods Sold (COGS), Gross Margin and Net Income growth trends.
  2. Balance Sheet (BS): Look at Cash, Debt and Retained Earnings
  3. Cash Flow Statement (CF): We will look at Debt Service Coverage Ratio and Free Cash Flow

Cashflow Statement (CF)

A Cashflow Statement tells you how cash is coming in, Cash Inflow and how cash is going out, Cash Outflow of the company. Ideally, we want CF to be positive every month and throughout the year. Reviewing a company’s CF statement tells you if it is able to make payroll, pay all expenses, and meet its debt obligations easily. Cash Inflow should be greater than Cash Outflow in any period, but certainly within a fiscal year.

Note that some companies that have seasonality may not have positive cashflows in certain quarters, but that does not necessarily mean that the company is financially poor. In such cases, the company may resort to some or all of the following, so that they can meet payment obligations, on time.

  1. Invoice Financing or Factoring: Borrow short term loans from the bank against future revenues.
  2. Bridge Loan
  3. Mezzanine Loan
  4. Issue corporate bonds
  5. Sell more shares to raise capital

Although an Income Statement will also tell you about a company’s ability to meet its obligations, a CF statement is important because it tells you how much cash it actually generates. For ex, an IS will book Revenue Receivables, however, the cash for this has not arrived in the company’s bank account yet. So many companies may look profitable based on the IS, however, it is not generating enough cash to meet obligations on time and therefore may not be able to survive in the long run.

Let’s go back to our Sports Sector and look at  Nike’s Cashflow Statement.

Once again, I am using the Marketwatch website.

I won’t go into the details of every line item in a CF statement. Instead, I will show you how to look at 2 metrics we can derive using the CF statement and quickly decide if the company is healthy or if there are any red flags.

Sources of Cashflow

A company can generate CF through 3 activities:

  • Operating Activities: These are cash a company brings in or pays out from its core business operating activities. In the case of Nike, these will include receivables (usually sales revenue), payroll, paying for raw materials, utilities, taxes etc. Investors should carefully view this section.
  • Investing Activities: These are cash a company spend on capital assets such as plant, equipment. In the case of Nike, it could be building and leasehold improvements, owned store fixtures and improvements etc.
  • Financing Activities: These are cash a company generates from securing loans, issuing bonds, paying interest on loans etc. In the case of Nike, it includes dividends paid, debt and interest payments, etc.

4 Tricks to Reading a Cashflow Statement

1. Operating Activities

We want to know if the company is generating sufficient positive cash flow from operations to cover its current, short-term liabilities. 

Nike Cashflow Statement, Operating Activities. Source: Marketwatch

We can clearly see the Nike has consistently grown its Operating Cashflow from $3.1 Billion in 2016 to $5.9 Billion in 2019, a 90% increase. 2020 is likely to show a lower CF due to Covid19.

2. Investing Activities

Since this is not the core business for Nike, rather Nike invests in plant, equipment, leasehold improvements and other capital expenditures to grow the business, it is not necessary for the CF from Investing activities to be positive.

Nike Cashflow Statement, Investing Activities. Source: Marketwatch

Nike had negative CF of $264 Million in 2019.

3. Financing Activities

We can see that CF from Operating Activities + CF from Investing Activities is positive for Nike. In 2019, it was $5.9 B – $264 M = $5.6 B. This is important as it means Nike should have sufficient cash to meet its financing obligations such as payment of debts, dividends, share buybacks etc.

Nike Cashflow Statement, Financing Activities. Source: Marketwatch

You can see the Nike paid dividends ever year, repurchased its own shares, paid off debt in 2016 and 2019, and issued debt in 2017 and 2018.

Nike also issued new shares to raise capital.

4. Free Cash Flow (FCF)

This is the golden number. As it sounds, FCF tells us how much Free Cash is left with the company after paying all its current liabilities. FCF tells us more than Net Income. (We saw Net Income in the Income Statement). While Net Income says how profitable the company is, FCF tells us how much real cash a company has left to grow the business or pay dividends to shareholders or buy back shares. In the CF statement, FCF is usually the last line item.

FCF = Operating Cash Flow − Capital Expenditures

FCF = $5.9 B – $1.12 B = $4.78 B

Nike FCF, Cashflow Statement. Source: Marketwatch

In 2019 Nike’s FCF was $4.78 Billion

NIKE has always maintained very healthy FCF and over the years it has grown nicely. In the snapshot blow, FCF grew from $1.95 Billion in 2016 to $4.78 Billion in 2019.

Nike’s Board approved a significant share buyback program between 2012 and 2020 funded by the FCF. According to Nike’s 4th Quarter Financial Reports:

Share repurchases totaling $3.0 billion for fiscal 2020 reflecting 33.5 million shares retired as part of the four-year, $15 billion program approved by the Board of Directors in June 2018″

“During the fourth quarter, NIKE, Inc. repurchased 1.9 million shares for approximately $159 million before suspending share repurchase activity in March to maximize liquidity in the current dynamic environment.

Comparing Nike & Lululemon

FCF: Lululemon has had a much better growth in FCF than Nike has. However, in absolute dollars, Nike’s FCF is significantly bigger than that of Lululemon. 

Lululemon VS Nike, FCF Growth From 2016-2019
Lululemon VS Nike, FCF From 2016-2020. Nike data for 2020 was not available.

Conclusion

The Income Statement, Balance Sheet and Cashflow Statements can together help you assess the financial health of a company. Comparing certain ratios with the sector index or competitors will give you an even better perspective. There are many more ratios and data you can review or analyze. For example, the company’s website will usually share the entire statements along with notes to the statements from management as well as auditors. These will also shed a lot of light on what the management believes about the growth and risks the company faces. 

My goal here is to help you quickly look at a few key ratios or trends so you can ask a few intelligent questions to your investment advisor or broker.

2 questions you can ask about Nike’s Cashflow statement:

Nike took a lot more debt in 2020 as we saw from the BS. Nike’s sales maybe hampered due to Covid 19 for the rest of 2020. . 

  1. What impact will this have on FCF?
  2. What impact will it have on DSCR?

You may want to read these 4 blogs in the series as well.

As always you can reach me on Twitter @saq3 or LinkedIn @Shaheeda Abdul Kader, or leave a message at say@shaheedasays.com.

Disclaimer:

I am NOT a certified broker or financial advisor. Please DO NOT make investment decisions based solely on my blogs. My intention is to show you how to research stocks or funds for yourself so you can feel empowered and knowledgeable to do your own investigations and invest with confidence. It is best to consult with your broker or advisor if you have questions. You can also reach me and I’ll do my best to help you with your queries.

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Shaheeda Abdul Kader

After 25 years of working for corporations, being an entrepreneur and managing investments for my family, I now want to help others find their financial freedom