Yesterday I discussed the first of three acts of a companies Financial Statements.Income Statements for beginning investors. Today Act 2, Cash Flows. And we will explore it in all its breathless glory.

Once again we will utilize the cash flow from Morningstar for VaxGen Inc. (VXGN) to save ourselves the difficulty of sifting through the 10k and 10Q to get mostly the same info.

The question you should be asking yourself right now is, If I have already seen how a company is making or losing its money in the income statement why do I need to look at the Cash Flow. I am so glad you asked that question.

Some investors like to argue that the Cash Flow statement is a better source of  information than the Income Statement because it is easier for Management to manipulate the numbers in an income statement. I am of the opinion that if Management wants to manipulate the numbers they can and will. Warren Buffett looks for companies with good and honest management.  Very good advice to follow. Sometimes hard to determine.

I do believe the Cash Flow statement contains some special information that we will get to at the end.

The cash flow statement begins the section entitled Cash Flows from Operations

Line 1 Net Income- This line is an old friend. It is literally copied from the Income statement.

Cash Flow Statement for beginning investors

Line 2 Depr & Amort, which is not the disease you get where you begin using foul language all the time. It stands for Depreciation and Amortization. Depreciation of Assets isn’t an actual outlay of cash, it is a measurement of the decrease in value of an asset that has been accounted for already. When you want to spread costs over a longer period of time, you Amortize the costs.

Line 3 Deferred Taxes. I think this is something we all aspire to do.

Line 4 Other. In this case Other refers to Other components that involve operations such as changes in inventory or accounts receivable etc.

Line 5 Cash Flow from Operations. Total up everything before and you have the number.

Next Section: Cash Flow from Investing. I would say that is it is what it sounds like, but that is only partially true. Buying equipment or businesses may be investments but in the sense that an investor thinks of an investment.

Line 6 Capex or Capital Expenditures. This involves purchases of equipment a business to keep it going. Or that management thinks they need if it is a corporate jet.

Line 7 Purchase of Business. When a shark swallows eats a fish, no that is in nature. I think you get the point.

Line 8 Other – Other cash flows from intesting.

Line 9 Cash from Investing. Total up lines 6 though 8

Next section Cash flow from Financing. Yup you go this one covered.

Line 10 Net Issuance of Stock. Yeah. You sell stock in your company it is cash in, buy it back it is cash out of the company.

Line 11 Net Issuance of Debt. Borrow money, issue a bond, cash comes in, Pay it off cash goes away.

Line 12 Dividends. Dividends paid out to shareholders.

Line 13 Other. Other smaller items that result in Cash Flow from financing.

Line 14 Cash from Financing. Total up lines 10-13.

Line 15 Currency Adj.  Adjustments to currency.

Line 16 Change in Cash.  This is a change in the cash available from the previous year.

The Final Section is Free Cash Flow.

Line 17 Cash from Operations. Just copy from above.

Line 18 Capex. Also a copy from above, so that you can get…

Line 19 Free Cash Flow. Sum Line 17 and 18 and you get Free Cash Flow (FCF), which is a magic number in value investing. It tells you better than Net Income whether or not a company is a good business to invest in the long term.  A company that generates positive FCF is able to pay all its bills including Capital expenditures and still have something left over. That something is shareholder value. Unless the Man issues to many options for himself.

Tomorrow Act 3 the Balance Sheet.

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