Saturday, 26 May 2018

1MDB: Dissecting One Of The World's Biggest Financial Scandals

Published on 5 May 2017

@1.00.30  What will you do with the money recovered from 1MDB?

@1.02.30  Who in Malaysia is chasing this money?

@1.04.00  What has Malaysia done about this?  Nothing.

The Attorney General of Malaysia has cleared the Prime Minister of any wrong doing.  So this is a perfect crime.
Malaysia is suppose to be the victim.  The victim itself seems to be totally unable to do anything ...  as long as the Prime Minister and his political appointees represent the people of Malaysia.

But then again remembers, crime pays.  Some of it anyway.  Lots of it.

Wednesday, 23 May 2018

1MDB: Malaysian Finance Minister lambasted Arul Kanda as "utterly dishonest and untrustworthy".

Image result for integrity hardworking intelligence

Malaysian Finance Minister, Lim Guan Eng, lambasted Arul Kanda as "utterly dishonest and untrustworthy".
"Arul Kanda claimed that all financial matters were handled strictly by the company CFO and he is uncertain what the value of these investments are – or whether they exist in the first place.
"It is completely unbelievable that a highly-paid and experienced investment banker can be so irresponsibly clueless as to not know whether RM9.8bil worth of investments are even real," said Lim.
Lim said he had instructed the ministry's legal advisers to review Arul Kanda's position as president of 1MDB.
The ministry will also appoint PwC to conduct a special position audit and review of 1MDB.

Check out the video


I answered what I knew, says Arul
FMT Reporters | May 24, 2018
The 1MDB boss says he answered based on what he knew in the absence of documents to back him.

Unfair of finance minister to put me in bad light
Arul Kanda Kandasamy

Wednesday, 16 May 2018

Hartalega 4Q net profit up 30%

Justin Lim/
May 15, 2018 18:54 pm +08

KUALA LUMPUR (May 14): Hartalega Holdings Bhd’s saw its net profit jump 30.7% to RM116.8 million in the fourth quarter ended March 31, 2018 (4QFY18), from RM89.4 million a year earlier.

The world’s largest synthetic glove manufacturer’s quarterly revenue rose by 17% to RM616.84 million, from RM527 million in 4QFY17. Earnings per share was at 3.53 sen in 4QFY18, compared with 2.72 sen the previous year.

For the full year (FY18), Hartalega reported a net profit of RM440.1 million or 13.29 sen per share, up 55.4% from RM283.3 million or 8.62 sen per share in the previous year. Revenue also increased 33.33% to RM2.4 billion, from RM1.82 billion in FY17.

Its group managing director Kuan Mun Leong said in the statement: “This marks another significant milestone for the Group. Our strategic plans continue to bear fruit, enabling us to deliver a strong performance on the back of increased sales volume, in tandem with our continuous expansion in production capacity and robust demand for nitrile gloves.”

On prospects, Hartalega expressed its confidence in propelling the group forward in the coming year, as it is driven by its strategic expansion plans and product innovation,” Kuan said.

“As we move forward, we are well on track to meet growing global demand, driven by our Next Generation Integrated Glove Manufacturing Complex (NGC). To this end, we have successfully commissioned all 12 production lines in Plant 4 of the NGC. We target to commence commissioning of Plant 5 in July 2018 and subsequently, the construction of Plant 6. We are also planning to construct an additional Plant 7, which will focus on small orders and specialty products,” Kuan added.

Additionally, Hartalega is also set to launch its antimicrobial gloves in Europe on May 31, 2018, Kuan said.

“We are also currently in the process of securing approval from the Federal Drug Administration to enter the US market with this latest product,” Kuan added.

Hartalega shares closed unchanged at RM6 today, with 4.9 million shares traded, giving it a market capitalisation of RM20.14 billion.

Hartalega - FY18… a Slight Anti-climax
Author: HLInvest | Publish date: Wed, 16 May 2018, 09:39 AM

Hartalega’s FY18 Core PATAMI of RM399.0m (+23.2% yoy) was below our expectation and consensus. Production capacity rose to 28.5bn with a utilization rate of 91% in FY18. Our forecast is unchanged and we maintain our HOLD rating albeit with a higher TP of RM6.17. We expect the share price will be supported by (i) it’s possible inclusion into the KLCI come June review (ii) sentiment driven weakness in the Ringgit will continue to whet investors’ appetite for export stocks.

Below expectations. FY18 core PATAMI of RM399.0m (+23.2% yoy) came in below at 94% and 92.4% of ours and consensus full year estimates, respectively. The lower than expected results were due to higher (i) energy costs (natural gas) (ii) butadiene prices and (iii) finance costs.

Dividends. Declared a third interim dividend of 2 sen/share (FY17: 8 sen/share).

YTD. Revenue grew 32.1% yoy to RM2.41bn on the back increased sales volume (+33% yoy), greater operational efficiencies and a higher utilization rate (FY18: 91% vs. FY17: 87%). EBITDA margins expanded by 2.8ppts (FY17: 23% vs. FY18: 25.8%). Subsequently, core PATAMI grew 23.2% yoy to RM398.0m on the above mentioned factors.

Yoy. Revenue grew 17.0% to RM616.8m on higher sales volume (+30.1%). EBITDA margin declined marginally by 0.2ppts to 26% as ASP saw downward pressure, offset by 17 extra lines yoy (4Q18:93 lines vs. 4Q17: 76 lines). Consequently core PATAMI grew by 10.3% yoy to RM98.6m.

Qoq. Revenue grew 2.3% qoq on higher sales volume (+5% qoq). Core PATAMI declined by 7.1% to RM98.6m qoq on competitive pricing whilst utilization rate declined to 89% from 91% qoq.

AMG. Production capacity rose to c.28.5bn pcs in FY18 with the current 93 lines having a utilization rate of 91%. Hartalega will launch their anti-microbial gloves (AMG) in Europe later this month, whilst simultaneously being in the midst of securing FDA approval for the US market. We are of the view that it will take some time for Hartalega to secure orders for its AMG given the products infancy in the market.

Outlook. Commissioning of plant 5 (4.7bn pieces) will commence in June CY18 followed by construction of Plant 6. Hartalega also announced its plans for Plant 7 which has been earmarked for specialty products with a capacity of c.2.6bn pieces. Moving forward we expect utilization rate to remain stable at c.89%-91% on the back of robust global demand, however we may see margin deterioration as more gloves capacity come on stream thus putting a downward pressure on ASP.

Forecast. Unchanged as the results were only marginally below expectations.

Maintain HOLD, TP: RM6.17. Despite the marginal results shortfall, we reckon there are short term sentiment driven factors that may warrant share price support (or even possible upside). These include: (i) possible inclusion into the KLCI come June review (ii) sentiment driven weakness in the Ringgit will continue to whet investors’ appetite for export stocks in the near term. Given such, we adjust our TP upwards to RM6.17 based on CY19 EPS pegged to PER of 37x (from 31.8x). Our ascribed PER of 37x represents 1SD above Hartalega’s 3 year historical PER.

Source: Hong Leong Investment Bank Research - 16 May 2018

Monday, 14 May 2018

A fresh new chapter for Malaysia. What a wonderful day!

The majority has voted against Barisan National in this election.

The transition of power to Pakatan Harapan has been smooth and peaceful.

All Malaysians, irrespective of whom they voted for, can now unite to move this nation to greater success, prosperity and happiness.

Many are thankful for those who have provided the leadership in this election.

One lady on the street was so happy with Tun.  Quoting her:  "I disliked Tun in the past.  Today he is 92 and now I wished he will be with us as our PM forever."

History has been rewritten.

Tun Mahathir's achievements and leaderships, over his lifetime have been noted.

He will be remembered as one of the most colourful and greatest among the top world leaders.

Image result for election malaysia 2018

Image result for election malaysia 2018

Wednesday, 9 May 2018

A Framework for Improving Decisions

Smart organizations can improve decision making in four steps:

1.  Identification
2.  Inventory
3.  Intervention
4.  Institutionalization

The four steps to improving decision making.

1.  Identification

Managers should begin by listing the decisions that must be made and deciding which are most important.

For example,

  • "the top 10 decisions required to execute our strategy: or 
  • "the top 10 decisions that have to go well if we are to meet our financial goals."

Some decisions will be rare and highly strategic. 

  • "What acquisitions will allow us to gain the necessary market share?"

Others will be frequent and on the front lines. 

  • "How should we decide how much to pay on claims?"

Without some prioritization, all decisions will be treated as equal - which probably means that the important ones won't be analyzed with sufficient care.

2.  Inventory

In addition to identifying the key decisions in 1 above, you should assess the factors that go into each of them.

  • Who plays what role in the decision?
  • How often does it occur?
  • What information is available to support it?
  • How well is the decision typically made?

Such an examination helps an organization understand which decisions need improvement and what processes might make them more effective, while establishing a common language for discussing decision making.

3.  Intervention

Having narrowed down your list of decisions and examined what's involved in making each, you can design the roles, processes, systems, and behaviours your organization should be using to make them.

The key to effective decision interventions is a broad, inclusive approach that considers all methods of improvement and addresses all aspects of the decision process - including execution of the decision, which is often overlooked.

4.  Institutionalization

Organizations need to give managers the tools and assistance to "decide how to decide" on an ongoing basis.

For example, the managers can be trained to determine whether a particular decision should be made

  • unilaterally by one manager, 
  • unilaterally after consultation with a group, 
  • by a group through a majority vote, or 
  • by group consensus.  
In addition, they can also determine

  • who will be responsible for making the decision, 
  • who will be held accountable for the results and 
  • who needs to be consulted or informed.

Companies that are serious about institutionalizing better decision making can often enlist decision experts to work with executives on improving the process.

For example, the members of a decision analysis group can

  • facilitate framing workshops; 
  • coordinate data gathering for analysis; 
  • build and refine economic and analytical modes; 
  • help project managers and decision makers interpret analysis; 
  • point out when additional information and analysis would improve a decision; 
  • conduct an assessment of decision quality; 
  • and coach decision makers.

Regularly assess and review to improve the quality of your decision making.

An organization that has adopted these four steps should also assess the quality of decisions after the fact.  The assessment should address not only actual business results - which can involve both politics and luck - but also the decision-making process and whatever information the manager relied on. 

The organization should regularly performs "look-backs" on major decisions, and assesses not only outcomes but also how the decision might have employed a better process or addressed uncertainty better.

The Hidden Traps in Decision Making

Making decisions is one of the most important things we do in our daily living.  It is also the toughest and riskiest in some situations.  Bad decisions can damage your career, business and finances, sometimes irreparably.

So where do bad decisions come from? 

In many cases, they can be traced back to the way the decisions were made:
  • the alternatives were not clearly defined,
  • the right information was not collected,
  • the costs and benefits were not accurately weighed.
But sometimes the fault lies not in the decision-making process but rather in the mind of the decision maker.  The way the human brain works can sabotage our decisions.

Psychological traps

There are a number of well-documented psychological traps that are particularly likely to undermine decision making.  These include:
  • heuristics#, 
  • biases and 
  • other irrational anomalies in our thinking.  

Your best defense is AWARENESS

There are specific ways you can guard against them.  However, the best defense is always awareness.  

By familiarizing yourself with these traps and the diverse forms they take, you will be better able to ensure that the decisions you make are sound and that the recommendations proposed by others (your subordinates or associates) are reliable.

Additional notes:

These are unconscious routines we use to cope with the complexity inherent in most decisions.  These routines serve us well in most situations.  These simple mental shortcuts help us to make the continuous stream of judgments required to navigate the world.  But, not all heuristics are foolproof.  The resulting decisions often pose few dangers for most of us, and can be safely ignore.  At times, the decisions arising from these heuristics can be catastrophic.  What make all these traps so dangerous is their invisibility.  Because they are hardwired into our thinking process, we fail to recognize them - even as we fall right into them.

Sunday, 6 May 2018

What I’ve Learned After Making More Than 5-Figures In Dividends

What I’ve Learned After Making More Than 5-Figures In Dividends

By The Fifth Person on December 28, 2015

As investors, we all love dividends. Other than the thrill of seeing a stock you own rise higher and higher in the stock market, receiving passive dividend income from your investments every year is something we all look forward to.

So if you’re more of an income investor and looking to invest for dividends, your stock portfolio will be markedly different from someone who’s investing for high growth and capital gain. The stocks that will give good, consistent dividends may not necessarily be the kind that will grow by 20-50% a year and vice versa.

So if you investing for dividends, you have to invest accordingly and only pick the best stocks that will give the passive dividend income you want. The question is: How?

Over the years, our investments have received more than 5-figures in dividends. So if you’re slightly lost and looking for some direction, here are 7 quick steps that we personally use to pick the best dividend stocks around: (Hint: You can’t just look at dividend yield alone!)

#1 Look for Mid-Large Cap Stocks

The best dividend stocks are usually large, mature companies with stable revenue, profits and cash flow. These companies have little growth left in them. Because these companies are no longer expanding aggressively, the majority of their earnings can be returned to shareholders as dividends.

On the other hand, a smaller, high-growth company needs more cash and resources to grow and expand its business, leaving less money to pay shareholders dividends (if any).

#2 Dividend Payout Ratio is 50% or More

If a company is large, stable and isn’t seeking to grow aggressively any more, then the majority of the profits it makes should be returned to shareholders. So look for a company with a dividend payout ratio of at least 50% or more. For example, Nestlé (Malaysia) returns over 90% of its earnings to shareholders as dividends.

If a company has a low payout ratio, ask yourself why the company is holding on to the cash. Unless they have a good reason to do so or have a way to generate exceptional returns for shareholders, the majority of profits should be paid out as dividends.

#3 Track Record of Paying Consistent Dividends

The company should have a long and stable track record of paying consistent/growing dividends to shareholders. No point if a company is large and successful and has profits to distribute as dividends, but chooses to pay them out inconsistently.

The best track record is to see a company pay a consistently growing dividend over the last 5-10 years. This shows that as the company grows more and more successful, the management is also willing to share the fruits of its labour with its shareholders.

#4 Company’s Fundamentals Must Be Sustainable

Many dividend investors tend to ignore the overall aspects of a company’s fundamentals and primarily focus on the amount of dividends they can receive from an investment. While dividend yield is obviously important for someone seeking dividends, it is also important to consider the overall health of the company.

A company with deteriorating fundamentals (e.g. falling revenue, profits, cash flow, fading economic moat, etc.) cannot sustain its dividend payout in the long term. The less revenue and profit it makes, the less dividends it can pay.

Furthermore, a company with falling revenues and profits will see its stock price fall in tandem over time as investors start to realize the company is no longer performing as well. This fall in value will eat into any dividend gains you might have had at the start — leaving you back at square one.

So always make sure the dividend company you want to invest in will remain fundamentally strong and robust for many years to come.

#5 Company has Low CAPEX

As a dividend investor, you prefer to invest in a company with low capital expenditure (CAPEX). A company with high CAPEX means that it has to continually reinvest its profits in maintaining its business operations, leaving less to distribute as dividends.

For example, airlines have very high CAPEX as they need to continually maintain their aircraft and upgrade them to newer models after a certain amount of years.

So look for a company that’s able to maintain/grow its business with minimal CAPEX.

If you want help, you can always kick start the idea by downloading our watchlist of dividend paying stocks below:

#6 Company has Stable Free Cash Flow

Ultimately, a company must have real cash (not just profits) to be able to pay dividends to its shareholders. Even if a company is profitable but has negative or inconsistent free cash flow, it will have trouble paying stable dividends.

A smaller company that is seeking to grow might have negative free cash flow as it expands its business. But a large, stable company that dominates its industry should be producing high amounts of free cash flow year after year.

#7 Yield Must Beat Risk-Free Rate

The dividend yield you receive from a stock should beat the risk-free rate of the country you reside in. The risk-free rate is the lowest return you can theoretically get “risk-free”over a period of time.

In the US, if you plan to invest your money for ten years, then the risk-free rate is usually based on the return of the 10-year US Treasury note which is currently around 2.30%. In Malaysia, the risk-free rate is usually based on the guaranteed interest your EPF gives you which is 2.5%. However, since 2000, EPF has been able to give out between 4.25% to 6.75%, which is more than the minimal guaranteed.

If your dividend yield can’t beat your risk-free rate, you might as well put your money with the US Treasury / EPF since you face less risk investing in a US Treasury note / EPF than investing in a stock to generate the same returns.

The Fifth’s Perspective

There you have it! Seven quick steps to help you pick the best dividend stocks to invest in. As you can see, there are lots more items to consider other than just dividend yield!

So remember to check these seven criteria whenever you’re looking to invest for dividends.

Wednesday, 18 April 2018

Is an oil refinery a good business to own for the long term?

Is a refinery a good business to own for the long term? 

1. In the oil refining business, the cost of inputs 
(crude oil) and the price of outputs (refined products) are 
both highly volatile, influenced by global, regional, and local 
supply and demand changes. Refineries must find the sweet 
spot against a backdrop of changing environmental regulation, 
changing demand patterns and increased global competition 
among refiners in order to be profitable. 

2. Oil refining is a capital-intensive business.  P
lanning, designing,
permitting and building a new medium-sized refinery is a 5-7 year process,
and costs $7-10 billion, not counting acquiring the land. The cost varies
depending on the location (which determines land and construction costs† ),
the type of crude to be processed and the range of outputs (both of the latter
affect the configuration and complexity of the refinery), the size of the plant
and local environmental regulations.

3. After the refinery is built, it is expensive to operate. Fixed 
costs include personnel, maintenance, insurance, administration 
and depreciation. Variable costs include crude feedstock, 
chemicals and additives, catalysts, maintenance, utilities and 
purchased energy (such as natural gas and electricity). To be 
economically viable, the refinery must keep operating costs 
such as energy, labour and maintenance to a minimum. 

4. Like most other commodity processors (such as food, lumber and 
metals), oil refiners are price takers: in setting their individual 
prices, they adapt to market prices. 

5. Since refineries have little or no influence over the price of 
their input or their output, they must rely on operational 
efficiency for their competitive edge.
Because refining is caught 
between the volatile market segments of cost and price, it is 

exposed to significant risks. 

6. “Crack” Spreads 
The term “crack” comes from how a refinery makes money 
by breaking (or ‘cracking’) the long chain of hydrocarbons 
that make up crude oil into shorter-chain petroleum products. 
The crack spread, therefore, is the difference between 
crude oil prices and wholesale petroleum product prices 
(mostly gasoline and distillate fuels). Like most manufacturers, 
a refinery straddles the raw materials it buys and the finished 
products it sells. In the case of oil refining, both prices 
can fluctuate independently for short periods due to supply, 
demand, transportation and other factors. Such short-term volatility 
puts refiners at considerable risk when the price of one or the 
other rises or falls, narrowing profit margins and squeezing 
the crack spread. The crack spread is a good approximation 
of the margin a refinery earns. Crack spreads are negative if 
the price of refined products falls below that of crude oil. 
A major determinant of a crack spread is the ratio of how 
much crude oil is processed into different refined petroleum 
products, because each type of crude more easily yields a 
different product, and each product has a different value. 
Some crude inherently produces more diesel or gasoline 
due to its composition. 


Refining is “low return, low growth,capital intensive, politically sensitive and environmentally uncertain.” A refinery will close 

if it cannot sustain its profitability.

[The 3 Cs = Capital Intensive, Commodity Pricing and Cyclicality (volatile earnings).]

Sunday, 15 April 2018

Free Cash Flow to Equity

Free cash flow to equity

From Wikipedia, the free encyclopedia
In corporate financefree cash flow to equity (FCFE) is a metric of how much cash can be distributed to the equity shareholders of the company as dividends or stock buybacks—after all expenses, reinvestments, and debt repayments are taken care of. Whereas dividends are the cash flows actually paid to shareholders, the FCFE is the cash flow simply available to shareholders. The FCFE is usually calculated as a part of DCF or LBO modelling and valuation. The FCFE is also called the levered free cash flow.

Basic formulae[edit]

Assuming there is no preferred stock* outstanding:

  • NI is the firm's net income;
  • D&A is the depreciation and amortisation;
  • b is the debt ratio;
  • Capex is the capital expenditure;
  • ΔWC is the change in working capital;
  • Net Borrowing is the difference between debt principals paid and raised;
  • In this case, it is important not to include interest expense, as this is already figured into net income.

FCFF vs. FCFE[edit]

  • Free cash flow to firm (FCFF) is the cash flow available to all the firm's providers of capital once the firm pays all operating expenses (including taxes) and expenditures needed to support the firm's productive capacity. The providers of capital include common stockholders, bondholders, preferred stockholders, and other claimholders.
  • Free cash flow to equity (FCFE) is the cash flow available to the firm’s common stockholders only.
  • If the firm is all-equity financed, its FCFF is equal to FCFE.

Negative FCFE[edit]

Like FCFF, the free cash flow to equity can be negative. If FCFE is negative, it is a sign that the firm will need to raise or earn new equity, not necessarily immediately. Some examples include:
  • Large negative net income may result in the negative FCFE;
  • Reinvestment needs, such as large capex, may overwhelm net income, which is often the case for growth companies, especially early in the life cycle.
  • Large debt repayments coming due that have to be funded with equity cash flows can cause negative FCFE; highly levered firms that are trying to bring their debt ratios down can go through years of negative FCFE.
  • The waves of the reinvestment process, when firms invest large amounts of cash in some years and nothing in others, can cause the FCFE to be negative in the big reinvestment years and positive in others;[5]
  • FCFF is a preferred metric for valuation when FCFE is negative or when the firm's capital structure is unstable.


There are two ways to estimate the equity value using free cash flows:
  • Discounting free cash flows to firm (FCFF) at the weighted average cost of capital (WACC) yields the enterprise value. The firm’s net debt and the value of other claims are then subtracted from EV to calculate the equity value.
  • If only the free cash flows to equity (FCFE) are discounted, then the relevant discount rate should be the required return on equity. This provides a more direct way of estimating equity value.
  • In theory, both approaches should yield the same equity value if the inputs are consistent.

*Where there are preferred shares and minority interests, the dividends paid to them must be subtracted from the FCFF to get the FCFE.



Free Cash Flow (FCF) is calculated by taking the Operating Income (EBIT) for a business, minus its Taxes, plus Depreciation & Amortization, minus the Change in Operating Working Capital, and minus the company’s Capital Expenditures for the year. This derives a much more accurate representation of the Cash that a company generates than does pure Net Income:
Free Cash Flow Calculation graphic

FCF = EBIT x (1-tax) + D&A - Changes in Working Capital - Capex

What is the difference between operating cash flow and net income?

Cash flow and net income statements are different in most cases, because there is a time gap between documented sales and actual payments. The situation is under control if the invoiced customers pay in cash during the next period. If the payments are postponed further, there is a larger difference between net income and operative cash flow statements. If the trend does not change, the annual report may demonstrate equally low total cash flow and net income.

Usually, rapidly developing companies report low net income as they invest in improvement and expansion. In the long run, high operating cash flow brings a stable net income raise, though some periods may show net income decreasing tendency.

Constant generation of cash inflow is more important for a company's success than accrual accounting. Cash flow is a better criterion and barometer of a company's financial health. Managers and investors can avoid many traps if they pay more attention to operating cash flow analyses.

Read more: What is the difference between operating cash flow and net income? | Investopedia
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Reviewing The Cash Flow From Operations

Cash Flow Statement: Reviewing The Cash Flow From Operations
By Michael Schmidt |
Updated March 5, 2018

Operating cash flow is cash that is generated from the normal operating processes of a business. A company's ability to consistently generate positive cash flows from its daily business operations is highly valued by investors. In particular, operating cash flow can uncover a company's true profitability. It’s one of the purest measures of cash sources and uses.

The purpose of drawing up a cash flow statement is to see a company's sources of cash and uses of cash, over a specified time period. The cash flow statement is traditionally considered to be less important than the income statement and the balance sheet, but it can be used to understand the trends of a company's performance that can't be understood through the other two financial statements.

While the cash flow statement is considered the third most important of the three financial statements, investors find the cash flow statement to be the most transparent, so they rely on it more than the other financial statements when making investment decisions.

The Cash Flow Statement

Operating cash flow, or cash flow from operations (CFO), can be found in the cash flow statement, which reports the changes in cash versus its static counterparts: the income statement, balance sheet and shareholders’ equity statement. Specifically, the cash flow statement reports where cash is used and generated over specific time periods and ties the static statements together. By taking net income on the income statement and making adjustments to reflect changes in the working capital accounts on the balance sheet (receivables, payables, inventories), the operating cash flow section shows how cash was generated during the period. It is this translation process from accrual accounting to cash accounting that makes the operating cash flow statement so important.

The cash flow statement is broken down into three categories: cash flow from operating activities, cash flow from investing activities and cash flow from financing activities. In some cases, there is a supplemental activities category as well. These are segregated so that analysts develop a clear idea of all the cash flows generated by a company’s various activities.

1. Operating activities: records a company's operating cash movement, the net of which is where operating cash flow (OCF) is derived.

2. Investing activities: records changes in cash from the purchase or sale of property, plants, equipment or generally long-term investments.

3. Financing activities: reports cash level changes from the purchase of a company’s own stock or issue of bonds, and payments of interest and dividends to shareholders.

4. Supplemental information: basically everything that does not relate to the major categories.

Breakdown of Activities
Operating activities are normal and core activities within a business that generate cash inflows and outflows. They include:

  • total sales of goods and services collected during a period;
  • payments made to suppliers of goods and services used in production settled during a period;
  • payments to employees or other expenses made during a period.

Cash flow from operating activities excludes money that is spent on capital expenditures, cash directed to long-term investments and any cash received from the sale of long-term assets. Also excluded is the amount that is paid out as dividends to stockholders, amounts received through the issuance of bonds and stock, and money used to redeem bonds.

Investing activities consist of payments made to purchase long-term assets, as well as cash received from the sale of long-term assets. Examples of investing activities are the purchase or sale of a fixed asset or property, plant, and equipment, and the purchase or sale of a security issued by another entity.

Financing activities consist of activities that will alter the equity or borrowings of a company. Examples of financing activities include the sale of a company's shares or the repurchase of its shares.

Calculating Cash Flow
To see the importance of changes in operating cash flows, it’s important to understand how cash flow is calculated. Two methods are used to calculate cash flow from operating activities: indirect and direct, which both produce the same result.

Direct Method: This method draws data from the income statement using cash receipts and cash disbursements from operating activities. The net of the two values is the OCF.
Indirect Method: This method starts with net income and converts it to OCF by adjusting for items that were used to calculate net income but did not affect cash.

Direct vs. Indirect Method
The direct method adds up all the various types of cash payments and receipts, including cash paid to suppliers, cash receipts from customers and cash paid out in salaries. These figures are calculated by using the beginning and end balances of a variety of a business accounts and examining the net decrease or increase of the account.

The exact formula used to calculate the inflows and outflows of the various accounts differs based on the type of account. In the most commonly used formulas, accounts receivable are used only for credit sales and all sales are done on credit. If cash sales have also occurred, receipts from cash sales must also be included to develop an accurate figure of cash flow from operating activities. Since the direct method does not include net income, it must also provide a reconciliation of net income to the net cash provided by operations.

In contrast, under the indirect method, cash flow from operating activities is calculated by first taking the net income off of a company's income statement. Because a company’s income statement is prepared on an accrual basis, revenue is only recognized when it is earned and not when it is received. Net income is not a perfectly accurate representation of net cash flow from operating activities, so it becomes necessary to adjust earnings before interest and taxes (EBIT) for items that affect net income, even though no actual cash has yet been received or paid against them. (See What is the difference between EBIT and cash flow from operating activities?) The indirect method also makes adjustments to add back non-operating activities that do not affect a company's operating cash flow.

The direct method for calculating a company's cash flow from operating activities is a more straightforward approach in that it reveals a company's operating cash receipts and payments, but is more challenging to prepare since the information is difficult to assemble. Still, whether you use the direct or indirect method for calculating cash from operations, the same result will be produced.

Operating Cash Flows
OCF is a prized measurement tool as it helps investors gauge what’s going on behind the scenes. For many investors and analysts, OCF is considered the cash version of net income, since it cleans the income statement of non-cash items and non-cash expenditures (depreciation, amortization, non-cash working capital and changes in current assets and liabilities). OCF is a more important gauge of profitability than net income, as there is less opportunity to manipulate OCF to appear more or less profitable. With the passing of strict rules and regulations on how overly creative a company can be with its accounting practices, chronic earnings manipulation can easily be spotted, especially with the use of OCF. It is also a good proxy of a company’s net income; for example, a reported OCF higher than NI is considered positive, as income is actually understated due to the reduction of non-cash items.

AT&T Cash Flow Statement showing cash from operating activities.

AT&T Cash Flow Statement showing cash from operating activities.

Above are the reported cash flow activities for AT&T (T
) for its fiscal year 2012 (in millions). Using the indirect method, each non-cash item is added back to net income to produce cash from operations. In this case, cash from operations is over five times as much as reported net income, making it a valuable tool for investors in evaluating AT&T's financial strength.

The Bottom Line
Operating cash flow is just one component of a company’s cash flow story, but it is also one of the most valuable measures of strength, profitability and the long-term future outlook. It is derived either directly or indirectly and measures money flow in and out of a company over specific periods. Unlike net income, OCF excludes non-cash items like depreciation and amortization which can misrepresent a company's actual financial position. It is a good sign when a company has strong operating cash flows with more cash coming in than going out. Companies with strong growth in OCF most likely have more stable net income, better abilities to pay and increase dividends, and more opportunities to expand and weather downturns in the general economy or their industry.

If you think “cash is king,” strong cash flow from operations is what you should watch for when analyzing a company.

Read more: Cash Flow Statement: Reviewing The Cash Flow From Operations | Investopedia
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Operating Cash Flow: Better Than Net Income?

Operating Cash Flow: Better Than Net Income?
By Rick Wayman
Updated November 16, 2015 —

Operating cash flow is the lifeblood of a company and the most important barometer that investors have. Although many investors gravitate toward net income, operating cash flow is a better metric of a company's financial health for two main reasons. First, cash flow is harder to manipulate under GAAP than net income (although it can be done to a certain degree). Second, "cash is king" and a company that does not generate cash over the long term is on its deathbed.

But operating cash flow doesn't mean EBITDA (earnings before interest taxes depreciation and amortization). While EBITDA is sometimes called "cash flow", it is really earnings before the effects of financing and capital investment decisions. It does not capture the changes in working capital (inventories, receivables, etc.). The real operating cash flow is the number derived in the statement of cash flows.

Overview of the Statement of Cash Flows
The statement of cash flows for non-financial companies consists of three main parts:

Operating flows - The net cash generated from operations (net income and changes in working capital).
Investing flows - The net result of capital expenditures, investments, acquisitions, etc.
Financing flows - The net result of raising cash to fund the other flows or repaying debt.

By taking net income and making adjustments to reflect changes in the working capital accounts on the balance sheet (receivables, payables, inventories) and other current accounts, the operating cash flow section shows how cash was generated during the period. It is this translation process from accrual accounting to cash accounting that makes the operating cash flow statement so important.

Accrual Accounting vs. Cash Flows
The key differences between accrual accounting and real cash flow are demonstrated by the concept of the cash cycle. A company's cash cycle is the process that converts sales (based upon accrual accounting) into cash as follows:

Cash is used to make inventory.
Inventory is sold and converted into accounts receivables (because customers are given 30 days to pay).
Cash is received when the customer pays (which also reduces receivables).
There are many ways that cash from legitimate sales can get trapped on the balance sheet. The two most common are for customers to delay payment (resulting in a build up of receivables) and for inventory levels to rise because the product is not selling or is being returned.

For example, a company may legitimately record a $1 million sale but, because that sale allowed the customer to pay within 30 days, the $1 million in sales does not mean the company made $1 million cash. If the payment date occurs after the close of the end of the quarter, accrued earnings will be greater than operating cash flow because the $1 million is still in accounts receivable.

Harder to Fudge Operating Cash Flows
Not only can accrual accounting give a rather provisional report of a company's profitability, but under GAAP it allows management a range of choices to record transactions. While this flexibility is necessary, it also allows for earnings manipulation. Because managers will generally book business in a way that will help them earn their bonus, it is usually safe to assume that the income statement will overstate profits.

An example of income manipulation is called "stuffing the channel" To increase their sales, a company can provide retailers with incentives such as extended terms or a promise to take back the inventory if it is not sold. Inventories will then move into the distribution channel and sales will be booked. Accrued earnings will increase, but cash may actually never be received, because the inventory may be returned by the customer. While this may increase sales in one quarter, it is a short-term exaggeration and ultimately "steals" sales from the following periods (as inventories are sent back). (Note: While liberal return policies, such as consignment sales, are not allowed to be recorded as sales, companies have been known to do so quite frequently during a market bubble.)

The operating cash flow statement will catch these gimmicks. When operating cash flow is less than net income, there is something wrong with the cash cycle. In extreme cases, a company could have consecutive quarters of negative operating cash flow and, in accordance with GAAP, legitimately report positive EPS. In this situation, investors should determine the source of the cash hemorrhage (inventories, receivables, etc.) and whether this situation is a short-term issue or long-term problem. (For more on cash flow manipulation, see Cash Flow On Steroids: Why Companies Cheat.)

Cash Exaggerations
While the operating cash flow statement is more difficult to manipulate, there are ways for companies to temporarily boost cash flows. Some of the more common techniques include: delaying payment to suppliers (extending payables); selling securities; and reversing charges made in prior quarters (such as restructuring reserves).

Some view the selling of receivables for cash - usually at a discount - as a way for companies to manipulate cash flows. In some cases, this action may be a cash flow manipulation; but I think it is also a legitimate financing strategy. The challenge is being able to determine management's intent.

Cash Is King
A company can only live by EPS alone for a limited time. Eventually, it will need cash to pay the piper, suppliers and, most importantly, the bankers. There are many examples of once-respected companies who went bankrupt because they could not generate enough cash. Strangely, despite all this evidence, investors are consistently hypnotized by EPS and market momentum and ignore the warning signs.

The Bottom Line
Investors can avoid a lot of bad investments if they analyze a company's operating cash flow. It's not hard to do, but you'll need to do it, because the talking heads and analysts are all too often focused on EPS.

Read more: Operating Cash Flow: Better Than Net Income?
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