In this video, we will analyze the statement of cash flow. This is an important statement and it tells an important story about how senior management and the board of directors are allocating capital. It also translates earnings into cash flow. The two are often mistakenly confused as being one of the same, and nothing could be further from the truth. Financial theory dictates that the value of an investment is determined by taking the present value of all future cash flows. Note cash flows not earnings.

To begin with the statement of cash flows is one of those aggregate cumulative statements. Notice the header for the fiscal year ended which means that this is the cash flow for all transactions that occurred from one second after midnight on February 1 of last year, to precisely midnight on January 30 of this year. The cash flow state Statement ties into the other financial statements in two important ways. The net earnings on the first line comes from the statement of earnings and the cash on hand at the bottom of the statement ties to the balance sheet. The Cash Flow Statement segregates the activities into three buckets, cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities. Operating Activities, isolate the cash generated in use from the conduct of business.

Investing activities isolates the cash generated news from investing or divesting of capital assets or major lines of business. financing activities, isolates the cash implications of all debt and equity transactions. So, let's look at each of these in turn to get the scoop first operating cash flow. The Home Depot generated earnings of $3.3 billion and operating cash flow of 4.6 billion dollars. So obviously there's a material difference. Let's understand why.

When you look at the cash flows, I think of it in two components. First, there's the adjustment of net earnings for non cash charges. In Home Depot's case, we have amortization and depreciation, impairment charges and stock based compensation. Second, there's a need to true up the charges for the amount Home Depot has invested in working capital. Increases in current assets are a bad thing in the cash flow world, ie a negative cash flow. Whereas a decrease in a current asset is a good thing, ie a positive cash flow.

The opposite holds true for current liabilities. An increase in accounts payable is good for cash flow because we have yet to distribute cash to pay our suppliers. For those of you who don't have a financial background. This may seem counterintuitive. But if you think about it, it makes perfect sense. This is where the mismanagement of receivables and inventory can become obvious.

Before leaving operating cash flow, let me draw a few items to your attention. Note that interest expense even though technically it's a financing type expenditure is included in this section by virtue of its inclusion in net earnings. Second, operating cash flow is often confused with EBITDA. It's similar but not quite the same, because the operating cash flows include the interest that we just spoke of, as well as eBay ignores the change in the working capital. People often confuse operating cash flow with EBITDA, but hopefully you now appreciate there's a very important distinction. Even as a rule of thumb, it's a back of the napkin indicator, but it's amazing how many financial experts We'll throw even a numbers around in the context likening it to operating cash flow and quite simply, it's not.

Let's move on to the cash flows from investing activities. The most common item here is the capital expenditures or commonly known as cap x. There are two types of capex. Maintenance capex is the capital spending required to replace and maintain existing capacity, whereas growth capex is new capital spending used to grow the business. Unfortunately, it's hard to distinguish between the two and there's no requirement for separate disclosure. I always like to compare the cap X number to the depreciation if capex is higher than depreciation.

I'm hoping that the company is growing the business and evidence would be an increasing number of store locations. For example, if it's lower, my concern is that whether the company deferring capital. If a company buys a target company through an acquisition, the amount paid for the target will show up in this section. If the company sells off assets, then the proceeds of disposition will show up as a positive number in the cash flow from investing activities. The gain or the loss on the asset would show up in the reconciliation of operating cash flows. Let me take a moment to talk about the notion of free cash flow.

Another important measure that isn't readily disclosed anywhere in the standard set of financial statements. There are two ways to measure free cash flow on a levered basis and on an unlevered basis. unlevered free cash flow means without finance considerations. Think of it as the amount of cash available to all financial stakeholders, the lenders and the shareholders alike. Leverage cash flow On the other hand is the cash that remains leftover for the shareholders after the debt charges have been settled. In both definitions, the cash flows are net of capital expenditures.

The idea of calculating free cash flow is interesting because this represents the amount of cash left over, for which the senior executives and the Board of Directors must make a decision about what to do with this excess cash. Their decisions are often related to the investing and financing sections of the cash flow statement. If they do nothing, then the cash leftover should flow to the cash balance at the bottom of the page, which may not be the most efficient use of cash. They may choose to spend some of the leftover money to do acquisitions or invest in growth cap x, as we just talked about, or they may use the proceeds to tweak the capital structure or return capital to the shareholders. So if we look at the financing section of the cash flow statement principles, repayments are a use of cash, whereas new debt issuances would be a source.

Leftover cash can be used to make dividend payments to shareholders, or could be used to repurchase the company's own shares. In either case, the amount spent would be shown here as a negative number. If the company has no cash, the extent to which they're drawing down, or repaying their line of credit would be shown in this section as well. What's left over is the net change in the cash position during the year. Typically, this number does not mean a whole lot. Finally, it's worth pointing out the supplemental disclosure at the bottom of the page, which notes the cash payments for interest and income taxes.

If you compare these amounts to the income statement, you'll see how the gap accounting can result in different numbers. In this case, they are close but approximately 10% higher than the accounting expenses from these line items, which just reinforces the importance of under Standing that the accounting basis and the cash basis are different views on the business. So there you have it, how to read a set of financial statements and how to make sense in the numbers. Financial Statements always have a story to tell, in fact, lots of stories. Hopefully you can now pick up a set of financial statements and begin reading between the lines to get a sense of the real results. In our next lesson, I'm going to show you how to use an investment website to shortcut a lot of the analysis.

That's all for now. So until next time, don't stop you get to the top and get to the top don't stop