Stocks Investing 101 Part 3: How To Read Seedly Chicken Rice Limited’s Cash Flow Statement
So… You’ve figured out how to read an income statement and a company’s balance sheet:
If you’re reading this article now, well… good for you! You are that much closer to understanding how to invest in a company.
In this third and final instalment of the Stock Investing 101 series, we will examine the basics of cash flow statements.
Read together; this guide will equip you with the tools to analyse great stocks!
Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be or does not constitute financial advice, investment advice, trading advice or any other advice or recommendation offered or endorsed by Seedly or any other company. Investors should always do their due diligence before investing in any investment products or adopting any investment strategies.
TL;DR: How to Analyse a Cash Flow Statement
Click to Teleport:
- An Analysis Of Seedly Chicken Rice Limited
- Why Look At The Company’s Cash Flows?
- 1) Operating Activities
- 2) Investing Activities
- 3) Financing Activities
An Analysis Of Seedly Chicken Rice Limited
For this exercise, I’ll continue using the fictitious chicken rice company Seedly Chicken Rice Limited to explain the basics of evaluating a company in simple, delicious, bite-sized terms.
We have previously covered the company’s income statement and balance sheet.
So now, let’s look at the company’s cash flow statement.
Why Look At The Company’s Cash Flows?
Ever heard of the term
“Cash is King”?
You know that cash is good for you.
It allows you to purchase your necessities and also allows you to quickly go into investments when opportunities arise.
Similarly, for a company, it is important to have cash on hand for many reasons:
- Pay off expenses
- Capital expenditure
- Emergency
- Liquidity
The statement of cash flows or cash flow statement tells you about the cash entering and leaving the company.
Basically, it shows how the company is spending and utilising its cash and where all that cash is coming from.
The amount of cash a company has shows its liquidity, which is its ability to meet short-term obligations.
Without positive cash flows, the company may be in a dire position and even go bankrupt. And that’s NOT something we’re looking for when choosing a company to invest in.
The statement of cash flows is divided into 3 parts:
- Operating Activities
- Investing Activities
- Financing Activities
Let’s look at Seedly Chicken Rice Limited’s cash flow statement.
1) Operating Activities
This refers to the cash flows from operations. Operations here would mean the revenue-generating activities that the company is engaged in.
For Seedly Chicken Rice Limited, it would be:
Profit Before Taxation
Remember what we talked about in the first article about income statement? This is the profit that the owners of Seedly Chicken Rice Limited can pocket.
Depreciation Of Property, Plant, And Equipment (PPE)
Depreciation of their kitchen equipment due to use.
Net Gain On Disposal Of PPE
One day, the boss of Seedly Chicken Rice Limited realised that the stoves were taking too long to cook the chickens. The slow cooking led to customer orders being delayed, which eventually led to a loss in customers as they got impatient waiting for their food.
Convinced that he needed new and better stoves, he upgraded the stoves and sold off the old ones. Lucky for him, he managed to sell them at a gain.
Gain = Sale price – Net book value (where Net book value = Cost price – Accumulated depreciation)
Impairment of Receivables
Impairment occurs when Seedly Chicken Rice Limited caters their chicken rice to Company X for their company gala event.
Unfortunately, Company X goes bankrupt after their celebration and cannot repay its debt.
Interest Expense and Interest Income
More will be explained below.
Write-Off Of Intangible Assets
Intangible assets (for example, Seedly Chicken Rice Limited’s brand reputation) are tested for impairment (the process of writing off) at least once a year or whenever there is an indication of impairment, whichever comes first.
Impairment occurs when the fair value (the market or recoverable value) is lower than the book value (what is stated in the financial statements).
For example, if you buy a Huawei smartphone worth $1,000 and are supposed to use it for five years, the annual depreciation of the Huawei smartphone would be $200.
But because their reputation suffered, the fair value of the smartphone was affected.
So, if you wish to sell your phone after the first year, the book value of the smartphone is $1,000 – $200 = $800 (what it’s supposed to be worth).
But because of the whole Google Huawei fiasco, the second-hand phone shop offered to buy your phone at only $300.
Essentially, that means there is a $500 impairment (loss in value) to the phone’s value.
Write-Off Of Inventories
Over the year, they sometimes overestimated their sales and ordered too many chickens in advance.
As such, their unsold chickens turned bad and the amounts have to be written off since these chickens are “obsolete” and cannot be sold.
Changes To Working Capital
Working Capital = Current Assets – Current Liabilities
Changes to Net Working Capital = Working Capital (Current Year) – Working Capital (Previous Year)
You’ll notice that any increases this year to assets will be reflected as a negative number. Conversely, the reverse applies to liabilities. You’re probably wondering, “Why is an increase in inventory indicated as a negative number? Isn’t it a good thing?”
This is because there is a decrease in cash.
The cash outflow you experience when you gain other assets is because you have to pay for your purchase of inventory. However, this only applies to operating activities only.
2) Investing Activities
As the name suggests, this portion shows the cash flows from investments.
Investing activities can be in capital expenditure such as purchasing property, plant, and equipment (PPE), investments in subsidiaries (if any) and/or investments in financial markets. In this case, let’s assume that Seedly Chicken Rice Limited only has capital expenditure.
Purchase Of PPE
This refers to upgrading new stoves and purchasing new PPE when they opened a new chicken rice store!
When they purchased new PPE, their revenue and profit increased.
This shows that capital expenditure is utilised wisely as it is put to good use.
Proceeds From Disposal Of PPE
This refers to proceeds from selling off old equipment.
Interest Income Received
This refers to the Interest received on the cash they put in the bank, etc.
The company has chosen to deposit the $50,000 in cash into a bank account that pays 0.4 percent interest per annum.
That would give an interest income of $200. (You may think that’s very low. Maybe the company should put its cash in a better savings account instead!).
3) Financing Activities
This portion discusses cash flows from different methods of financing, such as the issuing of shares or the taking up of loans.
Dividends Paid
As shareholders, you are definitely interested in this, right? The good news is that Seedly Chicken Rice is a publicly listed company which pays dividends.
Some points to take note of:
- Not all companies pay dividends.
- If they do, check whether the dividends paid are consistent with the previous year or, even better, if they increased from the previous year.
- Check also whether the dividend payout ratio is sustainable. If the payout ratio is close to 100%, that is a red flag because it means the company is not retaining its earnings, which is not sustainable! (Note that REITs are the exception, as they must distribute at least 90% of their taxable income.)
Proceeds From Long Term Loans
The company borrowed $30,000 from the bank.
Interest Expense
The interest paid on their loans.
Referring to their balance sheet, they have a loan (long-term borrowing) of $30,000.
Assuming they are paying an interest of 2 per cent (technically too good to be true! But assuming somehow they did…), their interest paid would be $600 per year.
If you’ve followed through this far, congrats! You have finished learning the basics of the three Financial Statements. You may be asking…
But… What do these numbers actually mean?!
Fret not.
If you would like to stretch your learning further, we will put meaning to these numbers by explaining the different financial ratios and metrics:
Hungry For More Analysis And Discussion About Stock Investing?
Why not check out our Seedly community’s General Investing group and participate in the lively discussion about stock investing there!
Disclaimer: We’re not experts, but we just want to share the little that we know in hopes that it’ll help you take the first steps in your investing journey in 2024. Hopefully, this will help you better understand what our savvy community members are saying about investments on Seedly and help you succeed in the year ahead!
