This article is part of The 45-Minute MBA series, where you’ll learn everything you need to know about business to become an effective leader of your organization (in less than 45 min of reading).
So far this series we’ve looked at the income statement and balance sheet for Apple, Inc. The last financial statement I’m going to discuss is the cash flow statement. Cash flow is the change in a company’s cash balance during a particular time period.
Examining the cash flow statement is the most important way to gauge the health of a business. The cash flow statement shows you where the cash is coming from and where it’s going.
The cash flow statement breaks down your cash transactions into three separate categories: Operating, Investing, and Financing Activities. Here’s Apple’s Cash Flow Statement from Sept, 24th 2011 (amounts in thousands):
Apple’s cash flow statement was compiled by using the indirect method. With the indirect method, you start out with net income, make adjustments for non-cash transactions (depreciation), and then make adjustments for all cash transactions.
*Take a moment to compare Apple’s net income (at the top) with free cash flow (at the bottom). These are two significantly different numbers. Despite having earned nearly $26B in 2011, their cash balance dropped almost $1.5B from the previous year. As an investor, this would peak my interest and prompt me to take a closer look.
Cash Flow From Operating Activities
The best way to explain cash flow from operating activities is to show you how it’s calculated. Here are the steps to calculate it:
1) Start with net income
2) Add depreciation
3) Add deferred income (The cash received up front for a sale that hasn’t billed yet)
4) Subtract the increase in accounts receivables and inventory (If receivables and inventory go up, cash goes down and vice versa)
5) Add the increase in accounts payable (If payables go up, so does cash balance)
This calculation will provide you with the cash flow from operating activities. If you have any questions feel free to ask me in the comment section below.
Cash Flow From Investing Activities
The capital expenditures and investments that Apple made are accounted for under cash flow from investing activities. Capital expenditures are payments for property, plant, and equipment. Investments include the purchase and sale of marketable securities.
*After closer examination, it appears that Apple has negative cash flow this period because they invested a significant amount of cash in marketable securities. According to their annual report on SEC.gov, they purchased $102B of marketable securities and received $70B in proceeds from sales, resulting in a net difference of $32B in negative cash flow for activities related to investing. This provides me with some comfort as an investor. I’d much rather this be the reason for negative cash flow vs. not collecting receivables or moving inventory.
Cash Flow From Financing Activities
Financing activities include the payment of dividends, sale or purchase of company stock, and borrowing activity. Apple issued $831M shares of its own stock and paid a $520M finance charge in 2011. They don’t pay a dividend to shareholders.
As you can see from above, Apple finished the year with negative cash flow of $1.446B. According to the balance sheet, their cash balance dropped from $11.261B in 2010 to $9.815B in 2011. After taking a closer look, we realized that Apple invested a significant amount of cash in marketable securities which resulted in negative cash flow for the year. Despite having a negative cash flow, Apple still finished the year with a nearly $10B cash balance.
*If you’d like to view the actual financial statements of a publicly traded company like Apple check out SEC.gov. Just type in the company name or ticker symbol and click the report you’d like to view (the annual report is filed as 10-K).
If you have any questions about the cash flow statement or any of the financial statements we discussed, please feel free to ask me in the comment section below.
Learning how to read financial statements was one of the most important things I learned in my MBA program. Hopefully, in the 9 minutes or so that it took you to read my 3 articles on financial statements, I was able to teach you how to do this.
Quick Story
Before I sign off, I’d like to leave you with a quick story. About 10 years ago, before my formal business education, I bought my first stock – Sirius Satellite Radio (SIRI). This was prior to the merger with XM Satellite Radio. A friend of mine recommended that I check it out, so I did. My research involved reading a few paragraphs about the company and thinking it over for about 30 minutes before I made the purchase. I bought 2000 shares. After all, this stock was going to make me rich.
I held the stock for a few years until I attended my first business school class on how to read financial statements. I distinctly remember going home one night after class and looking up the financial statements for Sirius Satellite Radio for the first time. My heart sunk as I scrolled through their financial information.
After reviewing the statements, I realized that I invested most of my life savings in a company that had never turned a profit! It was a horrible investment.
I looked quickly over my shoulder to see if any one had noticed the stupid decision that I made (as if anyone was watching me at home on my computer)… then I logged into my investment account and I put in a sell order.
I couldn’t wait for the market to open the next day so that I could find some poor soul to buy my shares. Thankfully, I liquidated my position and walked away without losing my shirt. It was a close one.
The reason why I tell this story is because you may be in a similar position as I was. You may rely on your friends and advisors for financial advice. Do yourself a favor- After you read this article, log into your investment account and take a look at some of the investments that you own. What are the names of the companies? Do they have a history of positive earnings and cash flow? Do they have an excessive amount of debt?
If you see any red flags, I encourage you to pick up the phone and contact your trusted friends and advisors and ask them these same questions. Chances are… they won’t have the answers.
If you’re questioning your investment decisions, I encourage you to read the first 4 articles of the series that I’ve listed below.
How to Make Money Without a Job
Purpose of an Income Statement
If you’d like to join me on my mission to teach you everything I learned in business school in less than 45 minutes of reading, please enter your email address in the box on the right. There’s definitely some great content on the way.
As always, thanks for reading and have an excellent week.
Scott
Scott Mackes is a leader and founder of the site “Margin of Excellence”. Connect with Scott on facebook and twitter.
{ 4 comments… read them below or add one }
Suddenly my days at business school are haunting me all over again
I agree 100% that understanding cash flow is crucial to business. Those income statements are just a doozy. I always get dizzy eyed when I see liabilities, adjustments, and capital. Very hard to get your head around so thanks for explaining it so well.
Bryce
Hey Bryce! Sorry to haunt you. You’ll love the total package when I’m finished. You can indeed pick up alot of great info in the cash flow statement, definitely something I look at before I make an investment. Hope all’s well with you and thanks for the note.
“Cash Flow From Investing Activities
The capital expenditures and investments that Apple made are accounted for under cash flow from operating activities.”
Shouldn’t the last five words be “cash flow from investing activities?”
Paul, good catch. I just made the change. I’m a little nervous now that I have a CFA reading along : )