Horizon.my

If you are a business owner, you will agree that cash flow is king. Looking at earnings is only half the story. Too often we hear of companies making profits but in the end they still fail.

Earnings can be puffed up with fictitious accounting transactions. The telling sign is usually this…

While the company reports seemingly healthy profits, its debt level continues to rise.

So with a bit of effort, we have compiled a Cash Flow Statement for each of the Top 50 Bursa Malaysia companies covered (excluding banks). To access this, click on the Cash Flow link in the Investor Database.

The approach we have taken is different from the statutory format which I actually find confusing. What we have done is to work out the company’s Free Cash Flow and Residual Cash Flow.

Free Cash Flow is something like the cash earnings of a company. To get this figure, we take the accounting profit and adjust for several items including:

1. Depreciation and Amortization
These expenses do not reduce cash, so we add it back to earnings.

2. Capital Expenditure
Eg. Purchase of equipment. Say a company buys a machine – it usually does not expense the whole amount but will book it as an asset. Subsequently it will incur a depreciation expense against the asset every year. But in terms of cash flow when the company buys equipment, the whole amount is a negative cash flow. Therefore capital expenditure drains cash.

3. Working Capital
Receivables: When a company sells something, it may not collect cash immediately. The sale is booked and a profit is recorded. Without collecting cash that profit is meaningless. So to work out Free Cash Flow:
1. If Receivables Increase: Earnings – Increase in Receivables
2. If Receivables Decrease: Earnings + Decrease in Receivables
Basically the more you collect, the more cash flow you will have.

Inventory: Companies manufacture or buy stock with the aim of selling it for a profit. When things are not going so well, inventory starts to build up and this is a drain on cash.

Payables: Most companies buy things from suppliers on terms and will only pay for them 30-60 days later. Often the telling sign of a failing company is where is keeps stretching suppliers to conserve cash.

Below is an example Cash Flow Statement for Air Asia Berhad:

Air Asia is a company that claims to make money but its borrowings keep increasing. As you can see from above, most of the cash outflow is in capital expenditure. Air Asia says that it buys aeroplanes and what you need to decide is whether you believe their story or not. It operates in an industry where most companies are scaling back and price competition is cut-throat. Is Air Asia really doing what it says it’s doing? Does it have to keep spending on capital expenditure? Can it fill capacity at a profitable price? Is there a time bomb waiting to explode?

Look at what Warren Buffett had to say about the airlines business:

The airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. You’ve got huge fixed costs, you’ve got strong labor unions and you’ve got commodity pricing. That is not a great recipe for success.
Interview in 2002, The Age

The worst sort of business is one that grows rapidly, requires significant capital, and then earns little or no money. Think airlines.
Berkshire Hathaway, 2007 Annual Report