Statement of cashflows

Strawman did a great job describing the above in the weekly email, I won't double up. Since there are many non-accountants and beginners on SM I log the following.

Unfortunately, I am old enough to remember pre the SoC. The report was called the Sources and Application statement. S&A was an elegant reconciliation between the profit and loss a/c and the balance sheet, it was also useless for investors. Useless because it included numerous non-cash items, provisions, asset movements etc. How many hours I tried to pull it apart and put it back together!, That proved to be a waste of time. About 1990 the statement of cashflow arrived, it was the best improvement in accounting in 40 years, imo.

I recall an ASX top 20 CFO, commenting that investors, at last, had something useful to analyse, he didn’t like it because it disclosed too much. That means don’t ignore this data.

There are several ways I use this data. For micro companies reconciling receipts in the SoC with revenues in the P&L can tell you if sales are being received as cash or not. Useful for new companies. If not then ask questions.

Every year I reconcile CFO to NPAT plus depreciation and amortisation and look at the difference. I use a 3 and 5-year roll to smooth out the data. For most companies, this should be very close (+/- 5-10%), if not ask questions. For growing companies whose cashflow looks low, I adjust by adding back net working capital. Net = inventories plus accounts receivable less account payables over the time frame being looked at. This gives some more data or raises questions. Working capital build can be legitimate but also tells you about the nature of the business. This reconciliation is an element in quality investing, cashflows should flow through into the CFO. If not, there could be an undisclosed cash drain. Eg restructuring costs against a previous huge provision that is ongoing., and other non-disclosed expenses not being accounted for in the p&L.

At rare times, some companies try and scam the system. My experience is that these are usually not driven by deceit, not at the start anyway, but I believe usually management usually attempts to give themselves time to restore operations, sometimes that restoration never comes and behaviour gets worse (the slippery slope). The main thing to look out for is where management has the discretion to put negative CFO items into the CFI line and positive CFI items into the CFO line. There is a lot of grey in some of these items and they are not always disclosed if used as they should be. Examples may include, factoring inventory and using profits into CFO (financing items as operational cashflow), or asset sales as operational cashflow, or paying fees for the use of assets as CFI when they should be expenses (disguising expenses as investments)

Some of these items are hard to pick up but be aware they do occur. If you get wind of them, the usual best course of action is to quickly run to the hills. Sometimes eyeballing the CFO/CFI lines and just seeing if they make sense versus historical can help find anomalies or raise questions.

That’s all is have