Fundamental Analysis
8.1 – Overview
A crucial financial statement that shows how much cash the business is actually generating is the cash flow statement. You could wonder whether this information is not stated in the P&L statement. So, there are two possible answers: yes and no.
Think about the situation that follows.
Consider a little coffee shop that serves just coffee and light fare. The majority of the shop’s sales are made in cash, so if a customer wants a cup of coffee and a snack, he must have enough money to buy them. Let’s say the shop sells Rs. 2,500 worth of coffee and Rs. 3,000 worth of snacks on a certain day. The store made Rs. 5,500/- on that particular day. P&L reports revenues of Rs. 5,500, and there is no ambiguity with this.
Consider another laptop-selling company now. Let’s say for the purpose of simplicity that the store only sells 1 type of laptop at a standard fixed price of Rs. 25,000 per laptop. Assume the store sells 20 of these computers on a particular day. Obviously, the shop’s revenue would be Rs. 25,000 multiplied by 20 to equal Rs. 500,000. What if five of the twenty laptops were purchased on credit? When a buyer purchases anything on credit, they agree to pay for it in full at a later date. The numbers in this scenario would be as follows:
Cash sale: 15 * 25000 = Rs.375,000/-
Credit sale: 5 * 25000 = Rs.125,000/-
Total sales: Rs.500,000/-
Definitely, The P&L account for this shop would show a total income of Rs. 500,000, which on the surface may appear like a lot of money. It is unclear how much of this Rs. 500,000 is actually in the company’s bank account. What if this business needed to repay a debt of Rs. 400,000/- right away? Despite having a sale of Rs. 500,000, the company only has Rs. 375,000 in its account. As a result, the business is under a cash constraint and unable to pay its debts.
Firstly, This data is shown in the cash flow statement. The financial statements of an entity should always include a statement of cash flows. Therefore, in this context, a cash flow statement’s appraisal is crucial since it shows, among other things, the company’s actual cash situation.
In conclusion, every company’s financial performance is more genuinely based on liquidity or cash flows than it is on the profits generated during a specific time period.
8.2 – Activities of a company
It is crucial to comprehend “the activities” of a corporation before we can understand the cash flow statement. When you consider a company and its numerous business endeavors, you will see that they can all be grouped into one of the three conventional baskets. We’ll make sense of this via an illustration.
Consider a company with a strong corporate structure, such as a very reputable fitness center (Talwalkars, Gold’s Gym, etc.). What regular business operations do you anticipate a gym having? I’ll start by listing a few company activities:
Using display ads to draw in new clients
Employ fitness professionals to assist consumers with their workout
Replace worn-out equipment with new fitness-related items.
Obtain a short-term loan from a bank.
To raise money, issue a certificate of deposit.
To raise new funds for growth, distribute new shares to a select group of well-known friends (also called preferential allotment)
Invest in a young company developing novel exercise regimens.
Place any surplus funds in fixed deposits.
Invest in a new construction site in the area to create a new fitness center in the future.
Improve the sound system to make working out more enjoyable.
As you can see, the business-related tasks listed above are fairly different but all have some connection to the firm. These activities can be categorized as:
Operational Activities (OA): Operational Activities (OA) are activities that are involved in the regular core business operations. Sales, marketing, manufacturing, technology upgrades, resource hires, etc. are examples of typical operating activities.
Investment activities (IA): Activities involving investments that the business does with the hope of profiting from them in the future. Examples include keeping money in interest-bearing instruments, purchasing equity shares, purchasing real estate, machinery, and other non-current assets such as intangibles.
Financial activities (FA): Activities pertaining to all business-related financial transactions, such as paying dividends, paying interest on debt, taking on new debt, issuing corporate bonds, etc.
Any activity that a respectable business carries out falls into one of the aforementioned three categories.
Importantly, We shall now group each of the aforementioned three activities into three categories or baskets while keeping the aforementioned three activities in mind.
Use display ads to draw in new clients – OA
Employ fitness instructors to assist clients with their workouts – OA
Purchase new exercise gear to replace worn-out gear – OA.
Ask lenders for a short-term loan – FA
To raise money, issue a certificate of deposit (CD) – FA
Issue new shares to a select group of well-known friends to raise additional funds for growth (also known as preferential allotment) – FA
Invest in a young company developing novel exercise regimens – IA
Place any extra funds in a fixed deposit – IA
Invest in new construction in the area to open a fitness center there in the future – IA
OA says the sound system should be upgraded for a better workout.
In fact, Think about the company’s cash flow now and how it affects the cash balance. Cash is impacted by all of the company’s activities. As an illustration, the phrase “Upgrade the sound system for a better training experience” suggests that the business must contribute funds toward the purchase of a new sound system. As a result, the cash balance drops. It’s also noteworthy that the brand-new sound system will be regarded as a corporate asset.
The top table has been color-coded:
Blue is the color code for money increases.
The drop in money is highlighted in red.
Assets have a green and blue color coding.
The purple color scheme signifies liabilities.
When you start comparing the “Cash Balance” and “Asset/Liability” columns in the table, you will see that:
1. The company’s cash balance increases along with a growth in liabilities.
In other words, if the obligations decline, the cash balance does too.
2. The cash balance falls whenever the company’s asset value rises.
Accordingly, if the value of the assets falls, the cash balance rises.
The crucial idea when creating a cash flow statement is the one stated above. If you take this further, you will see that each company’s operational, financing, and investment activities either enhance (net increase in cash) or decrease (net reduction in cash) the company’s cash.
Consequently, the company’s overall cash flow will be as follows:
Net cash flow from operating operations plus Net cash flow from investment activities plus Net cash flow from financing activities is the company’s cash flow.
8.3 – The Cash Flow Statement
Now that you have a basic understanding of the cash flow statement, you can see why it’s important to evaluate the cash flow statement when evaluating the organization.
To explicitly indicate how much cash the company has generated across the three business activities, corporations typically divide their cash flow statement into three categories when presenting it. Here is the cash flow statement for Amara Raja Batteries Limited (ARBL), continuing with our former chapter’s example:
Since most of them are self-explanatory, I won’t go through each line item. Please note, though, that operating activities at ARBL have brought in Rs. 278.7 Cr. Keep in mind that a company’s positive cash flow from operating activities is always an indication of its financial health.
You can see that ARBL spent Rs. 344.8 Cr. on its investment operations. This makes sense because investing involves spending money, after all. Additionally, keep in mind that solid investing activity indicates to the investor that the company is committed to growing its clientele. Of course, as we move through this lesson, we will comprehend how much is regarded as healthy and how much is not.
ARBL spent Rs. 53.1 crores on its financing operations. If you look closely, the majority of the funds were used to pay dividends. Additionally, if ARBL takes on additional debt in the future, the cash balance would rise (remember the increase in liabilities, increases the cash balance). The balance sheet reveals that ARBL did not incur any new debt.
This indicates that over the fiscal years 2013–2014, the company spent a total of Rs. 119.19 Cr. in cash. Okay, but what about the money from the prior year? As we can see, the business made Rs. 179.986 Cr. from all of its operations in the prior year.
Examine the area that is marked in green (for the year 2013-14). The beginning balance for the year is listed as being Rs. 409.46Cr. Where did they obtain this from? It just so happens that this is the year’s final balance (refer to the arrow marks). The entire cash position of the company is Rs. 292.86 Cr. when current year cash equivalents (Rs. 119.19 Cr.) and a little currency exchange differential (Rs. This indicates that the business squandered money.
Observe that the opening balance for the fiscal year 2014–15 will now be the balance at the end of 2013–14. When ARBL releases its cash flow statistics for the year ended March 31, 2015, keep an eye out for this.
Let’s now go over some thought-provoking queries and responses:
What exactly does Rs. 292.86 Crs. mean?
1. This demonstrates in stark terms the amount of money ARBL has in its numerous bank accounts.
2. What is money?
Cash is made up of demand deposits and cash on hand. This is undoubtedly a liquid asset for the business.
3. Describe liquid assets.
Assets that are readily convertible into cash or cash equivalents are referred to as liquid assets.
4. Similar to the “current items” we examined in the balance sheet, are liquid assets?
You can, indeed.
5. If cash is an asset and it is current, shouldn’t it be listed under current assets on the balance sheet?
Yes, it is, and it is here. Look at the excerpt of the balance sheet below.
Now it is obvious that the balance sheet and cash flow statement interact with one another. This is consistent with what we previously discussed, which is that all three financial accounts are interrelated.
8.4 – A brief on the financial statements
The P&L statement, the balance sheet, and the cash flow statement of the company have been covered in detail over the course of the last few chapters. The Balance Sheet is prepared on a flow basis, while the Cash flow and P&L statement are prepared on a standalone basis (showing the financial status for the given year).
The P&L statement compares the amount of revenue the company generated with the amount of expense growth. Retained earnings, often known as the company’s surplus, are carried forward to the balance sheet. The depreciation amount is included in the P&L as well. The balance sheet includes the depreciation that was reported in the P&L statement.
The assets and liabilities of the business are described in the balance sheet. The corporation stands in for the shareholders’ money on the liabilities side of the balance sheet. The balance sheet is said to be balanced when the assets are equal to the liabilities. The firm’s cash and cash equivalents are one of the most important items on the balance sheet. This figure reveals how much money the business has on hand in its checking account. The cash flow statement provides us with this figure.
In fact, The cash flow statement reveals a company’s ability to produce cash and cash equivalents as well as its cash requirements to those who will be using the financial statements.
So far, we’ve examined how to interpret financial statements and what to anticipate from each one. How to analyze these numbers is still something we have not explored. Last, Calculating a few crucial financial ratios is one method of financial data analysis. In reality, the financial ratios will be the main topic of the following chapters.
CONCLUSION
- The cash flow statement paints a picture of the company’s actual financial position.
- Operating, investing, and financing operations make up the three primary functions of a lawful business.
- Every activity either brings in money for the business or costs it money.
- The total of the business’s operating, investing, and financing activities is its net cash flow.
- Investors ought to pay close attention to the company’s operating cash flow.
- Cash level rises as obligations rise, and vice versa.
- The level of cash declines as assets rise and vice versa.
- The balance sheet also includes the annual net cash flow figure.
- Because it provides information about a company’s cash flow, the Statement of Cash Flow is a helpful complement to its financial statements.