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Cash Flow Analysis in (Simplified) Value Investing

If you used to read company’s financial statement, you will know that the Indonesian standard format of financial statement comes as: 1. Statement of Financial Position (Asset, Liabilities, and Equities). 2. Statement of Profit and Loss (Revenue, till Net Income). 3. Statement of Changes in Equities and lastly. 4. Statement of Cash flows. Normally, if writer do a quick financial statement analysis, we only look at asset changes to company’s net income, and seldom look to Statement of Cash Flows, then the question comes. What is the difference between Statement of Cash Flows and Statement of Profit and Loss? What if the company made profits in Statement of Profit and Loss, but the cash received (stated in the Statement of Cash flows) is smaller? Then, What if the company stated negative cash flows? And so on.

So, before we continue, let’s look at the definition of cash flow from the beginning.

Statement of Cash Flows is similar to financial statement entirely, but the information stated only limited to the amount of Rupiah (or Dollar) that actually received or paid by company in certain period. In this case, if the company made revenues of Rp100 in first quarter 2018, that Rp100 could be received (in cash) in the second quarter, or later.

The simple analogy is: Let’s say you are a fund manager buying A company shares, and A company announced a Rp100 cum dividend payment on 15 March, and the payment date on 10 April. Because you still hold A company shares until the cum dividend date passed, you will be automatically deserved for the dividend. Therefore, when you make a financial statement of the first quarter period (as 31 March) to be presented to your client, in the statement, the dividend income of Rp100 can be stated, but in the statement of cash flow that Rp100 cannot be stated. Why? That’s because the dividend will be paid or transferred to your account on 10 April, so for the 31 March financial statement, the money is not received yet.

Once more, even as 31 March the dividend is not definitely received, but you are certainly get the money because you are still holding the A company shares until the cum dividend date passed. So, in the financial statement you made, you can state the Rp100 dividend income. Got it?

Beside the condition where ‘revenues are stated first, meanwhile the money received after’, the condition of ‘money are received first, but cannot be stated as revenues’ could also happen. For example, a developer company, where they received cash money from customers who buy properties, but the housing/office/apartment units are not handed-over (still in build progress), so the money received still cannot be stated as revenues, otherwise should be stated as down payment, accounted as debt. Thus, as seen in financial statement, company will receive some cash money from customers, but revenues are less than the money. The developer company can acknowledge the money from customers as revenues, if the property units has already handed-over.

Hence, finally the company statement of cash flows, in this case the cash flows from operating activities, will never be the same with its statement of profit and loss. Additional factors such as bank administrations, if you transfer/deposit to a bank, the money will be effective the next day (for example, if you buy an apartment unit for Rp1 billion cash, then it is almost impossible to pay with paper money right? Otherwise, you have to pay using bank transfer). This can also make discrepancy between statement of profit and loss and statement of cash flow from operating activities. In this case, you don’t have to worry if company booked some profit, but in statement of cash flows, the amount of money received is less, even more assuming the financial statement was made-over. Based on writer experiences, it is rare that financial statement be made-over from the statement of cash flows part. When the financial statement is made-over, for an experienced analyst, it’ll be easily noticeable from the statement of profit and loss, without seeing the statement of cash flows anymore.

The Importance of Cash Flow Analysis for Long Term Investing

Because of that, as conveyed before, when doing a quick analysis, usually writer stops at net income numbers. However, for a consumer goods company, where customers buy the daily needs products, the company will directly receive cash payments and that payments can be directly stated as revenues cause the goods are already sent to customers, after that this statement of cash flows would be important to analyze. So, you can be critical if, for example Indofood CBP (ICBP) reported revenues of Rp1000, but receivable from customers in the statement of cash flows is only Rp500. Because ICBP sells Indomie and sorts of, which the price per pack is cheap, then people buy it cash, and I never heard before that people buy Indomie in Alfamart but the goods are delivered a month after.

Fast moving consumer goods of PT Indofood CBP, Tbk

Differently, let’s say Waskita Karya (WSKT), where the company booked revenues of trillions of rupiah just from one tollway project. Because the money is huge, so that money would be actually received by company in a few weeks to several months after (the process of fund disbursement will need time). So ICBP revenues should only have a little discrepancy with its statement of cash flows. Simply, if other sector company used to have a slow turnover, in which WSKT won’t receive payments every day (if there is no projects, or the projects are still in progress, WSKT will not receive advanced payments), whereas consumer goods company has a fast turnover, as can be assumed that ICBP will receive cash payments every day. And you can check by yourself to the end of financial statement, the ICBP revenues has not much different to its statement of cash flows.

Beside consumer goods company, banking company normally has slight differences between statement of profit and loss and statement of cash flows. They sell services (mortgages, administration services, etc) directly to customers who pay interests cash, and customers get direct services. Therefore, banks could actually booked the money as revenues.

For companies other than consumer goods and banking sectors, statement of cash flows is not so important to come to attention, because it doesn’t describe the company’s ability in making profits or earnings power. The most important thing in valuing the intrinsic value of a company is its track record of net profits, growth of equities form year to year. Nevertheless, statement of cash flows become very important to analyze if, 1. You are planning to buy the company wholly/ become a majority shareholder of 2. You plan to forever hold the shares and make it a dividend machine.

If you owned and control A company, you will have the access and also responsible to the in-and-out cash flows, and maybe you will confuse yourself when you have to pay for suppliers, but sales money is not received. If you only buy one lot of A shares, you don’t have to worry about this. Similar if you only buy shares to get its dividend every year, the company would be able to pay dividend regularly not only when the company consistently making profits, but also when the cash flow is good and align with its statement of profit and loss. Because paying dividends should use cash money right?

Unfortunately, by far, if writer was asked what shares that can be hold forever in Indonesia stock market, whether we buy it in a big sum/majority or even only 1 or 2 lots, then based on forever holding shares criteria we have ever discuss here, writer don’t have many options beside consumer goods companies or banking companies. Otherwise, other sectors shares, although we can hold it for years, usually there will be time to sell it back. Back again, cash flow analysis only important for consumer goods companies and banks. Thus, for other sectors companies, we can save time by analyzing limited to its comprehensive statement of profit and loss.

By the way, writer intentionally writes about cash flow now because I just realize, since 2010 till now, we hasn’t discuss about cash flows. So, afterwards for you whom have read all articles in this blog from the beginnings till now, can give us suggestions about what writer hasn’t write before. Next week, we will share another stock analysis.

Any inquiries, send email to teguh.idx@gmail.com.

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