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Tuesday, March 29, 2011

A Simple Exercise on Cash Flows

Last week, I had written two posts about how to read the Cash Flow statement in an Annual Report. An old proverb says: The proof of the pudding is in the eating. The best way to figure out whether you have understood the basic concepts of the Cash Flow statement is to do a simple exercise.

Here are three companies and their condensed Cash Flow statements. Analyse the three on the basis of their Cash Flows, and explain which of the three companies you would like to invest in, and why. All three companies are popular among small investors, but their names have been deliberately hidden to remove any bias in your analysis.

Company ‘A’

(Rs crore)

Mar '10 Mar '09 Mar '08

Mar '07

Mar '06
Profit before tax 710.15 157.04 344.84 231.16 92.90
Cash flow - operations 344.66 4.88 105.47 49.48 3.78
Cash Flow - investing -406.21 -301.73 -12.00 -606.64 -232.01
Cash Flow - financing -14.15 160.97 -185.45 723.43 356.58
Incr/decr in cash -75.70 -135.88 -91.98 166.27 128.35

Company ‘B’

(Rs crore)

Mar '10

Mar '09

Mar '08

Mar '07

Mar '06

Profit before tax






Cash flow - operations






Cash Flow - investing






Cash Flow - financing






Incr/decr in cash






Company ‘C’

(Rs crore)

Mar '10 Mar ‘09 Mar ‘08 Mar ‘07 Mar ‘06
Profit before tax 213.64 216.23 195.62 181.01 91.90
Cash flow - operations 1148.20 206.11 -19.21 -271.94 -89.61
Cash Flow - investing 19.20 -844.59 -1410.82 -641.73 -434.46
Cash Flow - financing -1176.20 626.72 1388.16 1054.87 524.54
Incr/decr in cash -8.80 -11.76 -41.87 141.20 0.27

The last rows in each of the three tables is the sum of the previous three rows, giving the net cash at the end of each year. Negative numbers mean cash outflows; positive numbers mean cash inflows.

If you are one of those who gets scared by tables full of numbers, let me assure you that it isn’t my wish to scare you at all. It is far more scary to invest in the shares of a company without having a clue about how much cash it is generating and using up.

So put on your thinking caps, and give it a shot. Results (and the company names) to be announced next week. Needless to say, the most logical attempt(s) at answering will be duly acknowledged.

Related Posts

How to read the Cash Flow Statement – Part 1
How to read the Cash Flow Statement – Part 2


sai thilak said...

a shot at it.

Company C looking interesting. Cash flow investing figure for '06 - '09 were considerably negative. It looks to me they are capital expenditure/asset investing. That looks it paid off well in '10. One can see huge diff b/w cash from operations and net profit before tax. This difference could be deprecation on the assets that are acquired in previous few years.

These assets can well help company to rake in more profits in times to come. It looks like growth story.

Let me know what you think!

Doctor Universe said...

I think Company B is in the best shoes presently. It has enough cash from operations to look into the financing and investing. Also there is a net net cash increase of 59 cr in hand. And over the years it has shown improvement.

Company C s cash from opns is nullified with cash flow of financing which is negative.

TK said...

For my understanding I generally give a score out of -3 to +3 for any parameter to reach a objective conclusion.
Company A:Total score =10
1. Profit before tax: From 92.9 to 710.1. It has grown at a CAGR of 66.28.Great performance: score = +3.
2. Cash flow from operations: The figures have generally grown over the years with a very good growth rate. From 3.78 to 344.66. It can be assumed that the business model is maturing fast and have started giving good returns.
Score= +3
3. Cash flow from investing: Negative cash flow in investing means, assets are being created which will give returns in future. Since there is good cash flow from operations in the year 2010, a higher investment in the same year means company is consolidating its market position. This is good for long term health. Score = +3
4. Cash flow from financing: 3 out of 5 years, cash flow in this head has been positive. It means, the cash is not getting locked unnecessarily for the company. Score = +1
Company B: Total score= 5
1. Profit before tax: From 103.73 to 328.84. A humble CAGR growth of 33.44%. This a good growth.
Score: +2
2. Cash flow from operations: From negative cash flow to positive over 4 years. Company is maturing slowly and on a consisten path.

Score: +2
3. Cash flow from investing: Investments have decreased over 4 years. It means that company might not need any machinery or any other asset in near future and the demand for its product is stabilized. Though it means a smooth business, but growth in future might not be there due less investments
4. Cash flow from financing: Cash flow has been positive on financing
activities. Probably company has been paying off its loan steadily.Good for the company. Score =+1

Company C:Total score =8
1. Profit before tax: From 91.91 to 213.64. A CAGR of 23.48%. Its just
average. Score=+1
2. Cash flow from operations: Compnay is generating good cash from operations lately. Great performance in 2010. Score = +3
3. Cash flow from investing: Company has invested huge amounts in previous years and the cash flow has turned positive in 2010. Which means there is a gain in depreciation on machinery and will continue to be there in future as
well. score =+2
4. Cash flow from financing: Company had positive cash flow in previous years while as in 2010 its a big negative. Company may have paid up a big chunk of its loan in 2010 that it had taken in previous years. However, it needs to pay
more in future too. score =+2.

Considering above points: A preference list of companies for investment can be drawn as 1. Company A. 2. Company C, 3. Company B.

Subhankar said...

This is a comment from a subscriber who prefers to remain anonymous:

Prefer Company A - mainly due to:

1) The growth in PBT - assuming there are no major one-offs involved - they have been able to grow their profitablity at a much higher rate with consistent investments, when compared to B&C; also Company C despite the heavy levels of investing is not being able to translate it into profitability. A seems to be able to make more effecient use of their investments and convert them into profits

2) Consistent positive operating cash flow over the last 5 years

3) Also the levels of financing activities in B&C - for B am assuming the fall in financing cash flow is due to pay back of debt - which may still be required in the future, this is the same situation in C where the repayment of debt is taking a toll in '10. Also, if they had raised equity than debt in the financing - that could result in considerable dilution in the earnings. For A you see some payouts happening intermittently - assuming they are debt repayments - they should reduce the interest cost as well, while the same goes for C they could still be in for some huge repayments/dilution.

Overall, feel most comfortable with A, based on the strength of their profitability and ability to generate positive cash flow.
My second preference would be B - given that even they have shown decent profitability - the drag being in repayment/dilution due to the higher financing inflows
Least prefer C - who despite their high levels of investment have not shown higher profitability - but even if this is due to higher levels of depreciation as one of the comments suggested - I feel the rate of growth of profitability is lower - given the level of investments which they have been making.

Bharath said...

I would prefer Company A ( provided if all 3 companies are of same cadre/sector).
Reasons are
1) Company has grown phenomenonly ( provided if topline have also grown similarly, not by windfall gains/jump in margins)
2) Consistant positive cash flow
3) Consistant investing

Subhankar said...

This is a comment from reader Chandra:

Company B
1) Study growth of PBT
2) The net negative Cash flow gradually reduced over the years and turned into positive cash flow in Mar 10