121: How to Read a Statement of Cash Flows Like a CFO

Unlock the secrets to mastering cash flow analysis and elevate your financial savvy to the level of a CFO. In this enlightening episode of Boosting Your Financial IQ, I dive deep into the critical importance of cash flow for any business, revealing why even profitable companies can face bankruptcy without proper cash management. I'll unpack the structure of the statement of cash flows, providing you with the tools to interpret cash inflows and outflows strategically. You will gain a clear understanding of a company's liquidity and overall cash position with expert tips and secret hacks tailored for comprehensive analysis.

Discover the fundamental elements of the statement of cash flows as I break it down into its three main sections: operating activities, investing activities, and financing activities. Learn how each section impacts a company's financial health and explore vital metrics like net cash from operating activities, CapEx, free cash flow, and the cash flow to debt ratio. By analyzing trends over time and comparing periods, you'll gain deeper insights into a company’s operational efficiency and working capital management. For visual learners, check out my whiteboard walkthroughs on my YouTube channel linked below, and join my program at byfiq.com to further enhance your financial decision-making skills.

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Transcript

Speaker 1: 0:15

So, to truly analyze a statement of cash flows like a CFO, consider these hacks for advanced insights. This is Boosting your Financial IQ, where I help business professionals with financial responsibility to elevate their careers and run profitable companies. My hope is that you'll apply these lessons to achieve your greatest ambitions. Cheers and enjoy. Last week, we talked about how to read a balance sheet like a CFO, and in this episode, I'm going to teach you how to read a statement of cash flows, which is my absolute favorite. In like manner, I'm going to provide you with some expert tips and then, at the end, I'm going to reveal some secret hacks. So make sure you stay tuned.

Speaker 1: 0:54

Now the statement of cash flows. Right, it's my favorite financial statement. If you listen to my stuff, if you consume my content, if you watch my videos, if you're part of my program, you'll hear me say this over and over again Cashflow is king in any business. It drives value, it keeps a business alive, and the statement of cash flows is the most important financial statement you need to pay attention to. That's why I get all excited and jittery when I talk about this subject, so let's go ahead and jump right in. The statement of cash flows is a crucial financial statement that details how a company generates and uses cash over a specific period. Just unlike the income statement and balance sheet, which use accrual accounting, the cash flow statement provides a clear picture of the cash inflows and outflows, helping you to understand the liquidity and overall cash position of the business. See why it's so important. You can have profit and you could go bankrupt. In fact, 70% of companies that go bankrupt are profitable when they close their doors because they run out of cash. Bankrupt are profitable when they close their doors because they run out of cash. Now, reading a statement of cash flows like a CFO requires a strategic approach and a keen eye for detail. So in this episode, we'll explore how to read a statement of cash flows like a CFO, and I'll share some secret hacks to maximize your analysis. So, without further ado, let's go ahead and jump in by understanding the structure of the statement of cash flows.

Speaker 1: 2:23

Now, before I jump in, let me just say this If you're listening to this and you're wishing you could see all this because I'm a visual learner as well I got some good news for you. On my YouTube channel, at Steve Coffin, I've been dropping some videos. I've been dropping some videos where I walk you through on a whiteboard. I'm drawing it out. I have some good news for you because on my YouTube channel at Steve Coffin, I've been dropping some videos where I'll walk you through on a whiteboard how to read financial statements and how all this stuff works. So if you haven't subscribed to my channel, make sure you do that.

Speaker 1: 2:58

There's a lot of valuable information in the areas of strategy and finance. Now, if you want to take things to the next level and you're not a member of my program at byfiqcom, which stands for boosting your financial IQ, make sure you check that out, because that program is for business leaders, entrepreneurs, owners who want to learn how to make better financial decisions and have more impact in business, because business, that's where wealth is made. And if you don't understand how to read financial statements, if you don't know how to interpret the story behind the numbers, the value drivers in business, how to combine strategy and finance together all these things, if you don't know how to do that and you're running a company, you're missing out, you're leaving a ton of money on the table. That's what I did early on in my career and in my program. That's where I help you to avoid these traps and to kick some serious butt in business. All right, enough of that, let's get into understanding the structure of the statement of cash flows.

Speaker 1: 3:58

Now, quite simply, the statement of cash flows is not as scary as it may seem. Now most companies they don't look at the statement of cash flows, which drives me crazy because it's kind of complicated to pull. And most accounting software, even like the fancy schmancy pants ones like Oracle or QuickBooks and other sophisticated ones out there, they don't do a very good job of pulling the statement of cash flows. In fact, quickbooks, they hide their statement of cash flows because they're kind of embarrassed of it. So when you go in QuickBooks and you go to pull financial reports, you'll see the income statement and the balance sheet, but the statement of cash flows is kind of off to the side. But it doesn't have to be that way, it doesn't have to be so nuanced.

Speaker 1: 4:39

Let me just break it down here for you in this manner. So there are three categories operating activities, investing activities and financing activities. Let's start with operating activities. This section shows the cash that is generated from the company's core business operations. It includes cash receipts from sales, cash payments to suppliers and employees and and other cash expenses. The net cash provided by operating activities is a key indicator of the company's ability to generate cash from its primary business. The next section involves investing activities. This section details the cash flow related to the acquisition and disposal of long-term assets and investments. It includes cash payments for purchasing property, plant and equipment, pp&e, cash receipts from the sale of investments and other related activities. This is where you're going to find information about CapEx, which is critical in computing free cash flow.

Speaker 1: 5:41

The next section involves financing activities. This section covers cash flows related to the company's financing activities. It includes cash cash flows related to the company's financing activities. It includes cash receipts from issuing debt or equity, cash payments for repaying loans and making dividends to shareholders. This section shows how the company is financing its operations and growth. So here's the deal you can be losing money in your business and still stay in business for a period of time if you have cash from financing activities or from investing activities. But if you're losing cash in all three areas, your cash is going to be declining very rapidly and then, ultimately, you're going to be going out of business. So understanding where cash is coming in and out of the business is really important, and that's why understanding the structure is critical. All right, here's the formula to calculate the net increase or decrease in cash from these three sections, because that's ultimately what you get to at the bottom of a statement of cash flows is your change in cash. So net increase or decrease in cash equals cash provided by operating activities plus or minus your cash from investing activities, plus or minus your cash from financing activities, and then you end up with net change in cash and then your ending cash balance and then that ties back to the balance sheet. All right, so that's number one.

Speaker 1: 7:07

Number two is focusing on key metrics. So this is how I like to interpret the statement of cash flows is by using metrics, so paying attention to specific metrics and there's a ton of them. I'm just going to give you some basic ones to get you started. We'll help you to indicate how the company is generating cash and its liquidity position. So first we have net cash from operating activities. This metric indicates the cash generated from the company's core operations, its normal day-to-day business. A positive figure suggests that the company's operations are generating enough cash to sustain and grow the business.

Speaker 1: 7:46

All right, the next thing that you want to look at is CapEx. This represents the cash that is spent on acquiring or upgrading physical assets such as property, plant and equipment, and it's a critical indicator of a company's investment in future growth. All right, because if a company is not investing in CapEx and they require CapEx then it may mean that the business will not have the property, plant and equipment to sustain growth or to handle growth down the road. All right. The next key metric that I love to look at is free cash flow. This metric shows the cash available after accounting for capital expenditures and working capital. It's a key indicator of a company's financial flexibility and ability to return value to its shareholders. In other words, it's the amount of cash that is left over after accounting for everything in the business that is available to either pay down debt, to get back to debt providers, in other words, or to return to equity providers, or to make investments in the business. All right, so free cash flow is calculated simply on the statement of cash flows, by taking net cash from operating activities and subtracting out capital expenditures. Remember where capital expenditure is found. Yep, exactly Okay. If you said investing activities, you're following along. Good job, gold star goes to you. All right. The last metric is cashflow to debt ratio. This ratio measures the company's ability to cover its debt obligations with its operating cash. So a higher ratio indicates better financial health. So to calculate this ratio cashflow to debt you take net cash from operating activities and then you just divide that by total debt, right? So that's the second way to evaluate the statement of cash flows.

Speaker 1: 9:44

The next thing I do when I'm reading the statement of cash flows is I analyze trends over time. This helps me to identify changes in the company's cash position. So here's how to analyze trends First, compare periods. Look at cash flow statements from different quarters or years to see how cash flows from operating, investing and financing activities and just see how things are evolving. This will help you to understand the company's cash generation and expenditure patterns. No-transcript. Determine the growth rates for key cash flow items such as net cash from operating activities, capital expenditures and free cash flow. This provides insights into a company's cash flow trajectory. And then, lastly, I would assess consistency by checking key cash flow metrics over time. So if you have significant fluctuations from one period to the next, you will know where to dive in all right, and you'll know which line items require further investigation, all right. So that's the third thing I do when I'm reading financial statements, specifically the statement of cash flows.

Speaker 1: 10:56

Number four I like to dig deeper into cash flow components. So a high-level overview is essential. But as a CFO, I also have to dig deeper into specific cashflow components to uncover more insights. So here's some strategies. Number one operating cashflow. By analyzing components of operating cashflow, such as changes in working capital, like accounts receivable, inventory and accounts payable, this will help you to understand the efficiency of the company's operations and its working capital management. In other words, in your business, you may be having a problem with working capital and then, as you dive deeper into accounts receivable, you may realize that nobody's paying attention to accounts that go 90 days past due or 60 days past due or whatever it may be. So by understanding what's impacting working capital, by getting granular and getting into the weeds, you'll be able to spot opportunities to improve in the business. All right.

Speaker 1: 11:59

So the next thing I'd look at is investing cashflow. So scrutinize cashflows related to investments in assets and acquisitions, look for patterns in CapEx and proceeds from asset sales to assess the company's investment strategy and whether or not it's working. And then, lastly, I'd go to the last section, which is financing cashflow and I would look at cash related to debt and equity financing and I would identify any significant changes in debt levels, equity issuance or dividend payments to understand the company's financing strategy. All right, so that's how I would dig deeper into the cashflow components by looking at those three sections. And then, last but not least, before we get into the secret hacks is using benchmarking for context. So I like to use benchmarking to identify strengths and weaknesses in the businesses that I run, and I like to look at things on a macro scale, from an industry perspective, but also on a micro scale, from a competitive set perspective. Now, first, you could look at industry averages by comparing key cashflow metrics, such as operating cashflow, free cashflow and CapEx against industry averages, and this will help you to gauge your company's cashflow performance relative to competitors. You could also look at best practices and identify best practices from leading companies in the industry and then consider how they could be applied to your company's cashflow management strategy.

Speaker 1: 13:31

All right, if you're wondering, okay, I'm a privately held company, steve, where do I get this information from? You can start with Yahoo Finance, google Finance, bloomberg. You can look at public companies in your industry just to get a sense of what these ratios look like. But if you want to get more granular, that's where working with an accountant, a consultant or a partner will really help you out. I have proprietary data because I work with a ton of companies and I know what the number should be for most industries and therefore, when I work with companies, I can pinpoint exactly where they are on and where they're off. So if you ever want help with companies, I can pinpoint exactly where they are on and where they're off. So if you ever want help with this or you want to reach out to talk about a financial analysis, just hit me up. You could find me at cultivarcom. Go to my website. That's where I partner with companies to help them to grow and turn around. But you could connect with me there and we could talk and have a further discussion.

Speaker 1: 14:24

Okay, let me provide you with some secret hacks for advanced analysis. So, to truly analyze a statement of cash flows like a CFO, consider these hacks for advanced insights. So, number one common size analysis. So we talked about this with the income statement and the balance sheet. Do the same thing with the statement of cash flows. Convert each line item on the cash flow statement into a percentage of total cash inflows or outflows. This will make it easier to compare cash flow statements across periods or with other companies, regardless of size. So common sizing your financial statements always a good first step. Then you'll want to do variance analysis so you'll compare actual cash flows against your forecast and then investigate significant variances to understand the reasons behind them and take corrective actions if necessary.

Speaker 1: 15:17

There's also the direct method. While most companies use the indirect method for reporting operating cash flows, the direct method can provide a clearer picture of cash receipts and payments. So, if possible, analyze cash flows using the direct method for more detailed insights. Next, we have cash flow ratios. Use cash flow ratios, such as cash flow margin, net cash from operating activities divided by net sales and cash return on assets, net cash from operating activities divided by net sales and cash return on assets, net cash from operating activities divided by total assets, to gain deeper insights into a company's cashflow efficiency. Essentially, look at ratios, compare them to periods within your company, compare them to the industry, to your competitive set, and this will really help you to understand where the heck the problems lie and where the opportunities exist. And then, finally, stress testing. And then, finally, stress testing can be really helpful. This is done by modeling different scenarios, such as economic downturns and increased competition, to see how changes in external factors impact cash flows. This will help you to understand your company's resilience and preparedness for adverse conditions.

Speaker 1: 16:33

So, in conclusion, reading a statement of cash flows like a CFO involves more than just understanding the numbers. It requires a strategic approach, focusing on key metrics, analyzing trends and digging deeper into cashflow components, which we've been talking about in this episode. So, by using benchmarking and advanced analysis techniques, you can uncover valuable insights that drive better decision making and, ultimately, business growth. So, whether you're a seasoned executive or a business owner or an up and comer, these tips and hacks will help you to interpret the cashflow statement with expertise and precision of a CFO. So I hope you enjoyed this and be sure to share with your network. That would mean the world to me.

Speaker 1: 17:20

Like I said, check out my YouTube channel at Steve Koffrin. I'll provide a link in the show notes so you can click on that and check out the videos that I have available. And then, when you're ready to take things to the next level, you can join the program at byfiqcom and take your skills to a whole new level, which will help you to be a strategically minded leader that is focused on the right value drivers in your business. Or, if you're like you know what, steve, I just want you to come in and help me out. You could always connect with me at steve, at byfiqcom, which stands for boosting your financial IQ. You can head over to coltavarcom and you can connect with me there, or you can hit me up on social media. Regardless, I would love to hear from you. All right, that's all I have. I hope you have a great week and, until next episode, be sure to take care of yourself. Cheers.