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Monday, March 30, 2009

Read Your Cash Flow Statement

Pity the poor cash flow statement. It is not simple to understand like the balance sheet and it is no where near as sexy as the income statement. In most circles the cash flow statement is the ugly step sister of financial statements. I bet most of you who have a business don't bother to even read it. Mostly because it is harder to comprehend than a balance sheet and it is definitely not flashy, sexy mr bottom line income statement. I will even admit that in college I never did appreciate the cash flow statement. I memorized the mechanics so I could pass intermediate accounting, but it was not until I went to work for Arthur Andersen that I saw through to the heart and soul of cash flow statements and truly learned to appreciate their hidden beauty and inner strength.

I will get it out of the way right off, I went to work for Arthur Andersen right out of college. Yes that firm, the now defunct accounting firm, the one that gave us the glorious implosion know as Enron and led to the Sarbanes Oxley or as I like to call it the Guaranteed Accountant Employment Act. I even worked in the Houston Texas office, so throw eggs if you must. Personally I never worked on Enron and for all the bad press they got, there were a lot of very good qualified people that worked at Arthur Andersen. They also taught me how to appreciate cash flow statements. One of the first things you did as a newbie at AA was fly off to Chicago to spend 2 weeks learning the AA way of doing audits. Somewhere in that two weeks we covered how to prepare cash flow statements and it was during that lesson that I had my "AhHA" moment and to this day if given the choice I will look at the cash flow statement of a company to tell you how healthy the company really is.

You probably read that Rick Wagoner the CEO of General Motors is being forced out of his job. It seems President Obama decided that when you fly up on your private corporate jet and ask the federal government for billions of dollars to bail out your company, he expects you to take the money and say thanks we can survive now. Apparently Mr. Wagoner thought you could go back after a couple of months and ask father for more money. It doesn't work at my house with my kids and apparently it doesn't work in the current White House either.

You see I think Rick was looking at GM's balance sheet and income statement and did not really understand how bad the problem was. On their 12/31/08 balance sheet GM had $91,041 M in assets, just under half of that in current assets. (those are the ones you can theoretically convert in to cash quickly) Cruise over to the income statements for 2007 compared to 2008, last year was better. In 2007 GM lost $43,297 M from operations but last year they only lost $30,860 million. See things were looking up.

But if only Mr. Wagoner had taken the time to read the cash flow statement, he might have noticed that in 2007 which was not in itself a stellar year for the company GM generated $7,731 M of positive cash flow from operations. In 2008 they had negative cash flow from operations of over $12 billion. Even back in 2007 there should have been some red flags going up because all the positive operating cash flow that year was due to deferred income taxes. That is the kind of cash flow that tends to not recur year after year. I mean you can only loose money and get tax refunds for a limited amount of time.

There were certainly a lot more things in GM's cash flow statement that Rick probably should have noticed before the train wreck happened. But unfortunately for him he took that Harvard MBA degree and went to work for GM right out of college. Too bad he didn't do a stint with a defunct public accounting firm first.

If you want to read for yourself, click here.. General Motors scroll down to page 141, that is where the cash flow statement is and it is a "beautiful thing".

3 comments:

  1. A good book to read on this topic is How to read a Financial Report by John A. Tracy.

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  2. I can agree with your observations. On the other hand if we use EBITDA as an indicator similar effects as you describe would have been visible. I agree beforehand that with an asset intensive company like GM EBITDA is not the most ideal form, but on the other hand EBITDA is easier to understand by a lot of people. Please react.
    Gerard Verton

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  3. I agree EBITDA is probably the best ratio to measure how well a company's operations performed in one year. However, it falls into the same category as net income in that it is easy to understand but only measures the financial performance for one year. In GM's case you would have missed the fact that in 2008 they spend $7.5 billion on property purchases. I will admit I am not an expert on GM and that may be a normal amount for them to spend, but I don't believe 2008 was a normal year for them and I wonder why you would spend that much on new property when the company should have been contracting.

    As far as easy, I would also challenge you to read GM's 10-K at the link above and see how easy it is to calculate EBITDA for GM.

    Thanks for the comments.

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