Why focus on cash flows? Because a share of stock is a share of a company’s future cash flows, and, as a result, cash flows, more than any other single variable, seem to do the best job of explaining a company’s stock price over the long term.
- Jeff Bezos, 2001 Letter to Shareholders
The statement of cash flows is a financial report that shows the inflows and outflows of cash and cash equivalents for a business during an accounting period. It is one of the three fundamental reports in financial statements, primarily reflecting the impact of each item on the balance sheet regarding cash flow and categorizing them into three types of activities: operating, investing, and financing.
Cash flow from operating activities
Revenue from goods sold and services provided
Interest paid
Payment of income tax
Payments to suppliers of goods and services used in production
Wages paid to employees
Rent
Other types of operating expenses
Cash flow from investing activities
Short-term and long-term assets and investments
A company in healthy development continuously invests externally.
Therefore, the expectation is negative cash flow.
When it starts selling assets, the cash flow becomes positive.
Cash flow from financing activities
When raising capital, it is "cash inflow"
When paying dividends, it is "cash outflow"
The significance of the cash flow statement
Report on the receipts and payments of cash and cash equivalents
A company may have profits, but its cash could have decreased
The company has a loss, but its cash may have increased.
Reconcile net income on the income statement with cash on the balance sheet.
Used to analyze whether an institution has enough cash in the short term to meet expenses.
In the 2001 letter to shareholders, Jeff Bezos also proposed:
Since we expect to keep our fixed costs largely fixed, even at significantly higher unit volumes, we believe Amazon.com is poised over the coming years to generate meaningful, sustained, free cash flow. Our goal for 2002 reflects just that. As we said in January when we reported our fourth quarter results, we plan this year to generate positive operating cash flow, leading to free cash flow (the difference between the two is up to $75 million of planned capital expenditures). Our trailing twelve-month pro forma net income should, roughly but not perfectly, trend like trailing twelve-month cash flow.
Therefore, focusing on free cash flow can give the company more of a moat, whether through equity financing, debt loans, or stricter operating standards. Ensuring the company has sufficient free cash flow can help it get through tough times such as business stagnation or a capital winter. As long as your company survives while competitors fail, you will always have a chance to move ahead and gain a larger market share.
Winning or not depends on the opponent, but losing or not depends on oneself. Ensuring Free Cash Flow can keep the company in an unbeatable position.
Apart from obtaining more cash through financial means such as loans and financing, how to obtain more cash through operational means? Here we need to introduce the concept of Cash Conversion Cycle (CCC).
CCC refers to the number of days from when a company pays cash for inventory until it finally recovers the cash from selling the product. [1] The cash conversion cycle can be used to measure the liquidity situation of a company.
Cash Conversion Cycle = Days Inventory Outstanding + Days Sales Outstanding – Days Payable Outstanding
Therefore, if we want to shorten the cash conversion cycle, we need to reduce the days inventory outstanding, reduce the days sales outstanding, and increase the days payable outstanding. Especially when the business level of the company gradually improves and its negotiation ability strengthens, it can continuously seek better offers from suppliers and request later payments; conversely, it can also provide better services to make users willingly pay earlier, such as purchasing an annual subscription service.
It is said that during the 911 incident, many large companies extended their payment cycles and found that after the extension, many costs did not need to be paid because the suppliers went bankrupt due to broken capital chains. Although these suppliers' income and profits, total assets (the sum of cash and accounts receivable) did not change, cash flow indeed played a decisive role in the survival of the company.
Tomorrow we will continue to discuss Future Value and Present Value.