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Type of Securities Investment Strategies Fundamental Analysis Technical Analysis
Introduction to Fundamental Analysis Income Statement Analysis Balance Sheet Analysis Cash Flow Analysis Shareholders' Equity Analysis Ratios and Definitions


Introduction to Fundamental Analysis

 - The Accounting Process
 - Postulates and Principles
    of Accounting
    * Postulates of Accounting
     * Principles of Accounting

 -
The Financial Statements
   * The Balance Sheet
   
* The Income Statement
    * The Cash Flow Statement
    *  Shareholders' Equity
        Statement

 


The Cash Flow Statement

The statement of cash flow reconciles the accrual based income statement to the actual cash flow; it also pinpoints exactly where and how cash is being generated and used.

The three components of cash flow are:

1.      Cash flow from operating activities: Operating cash flow normally determines the value of a business. Most businesses are priced at a multiple of current or projected operating cash flow. Operating cash flow starts with net income, adds non-cash expenses like depreciation, and adjusts for all other operating cash items.  It reflects, among other things:

a.       Is the company generating cash flow from operations, or is it running deficits?

b.      Is cash being used to build inventory or receivables?

c.       Is the company generating cash by stretching its payables?

There can also be divergences between operating cash flow and net income.

The cash flow yield (operating cash flow ÷ net income) measures a company’s ability to generate cash flow in relation to its net income.

2.      Cash flow from investing activities: Investing cash flow indicates how management is investing for the future. Investing activities normally include such items as capital expenditures (Cap X), business acquisitions or disposals, and purchases and sales of investments.

3.      Cash flow from financing activities: Financing cash flow reflects the details of any debt and equity financing that occurred during the period, as well as dividends paid and treasury stock activity.

The actual parties involved in the financing activities, however, are normally not disclosed. The critical issue is: who is actually putting up the money to fund the business. More disclosure is needed in the area of who is “bankrolling” an organization. Since some of this information is available in newsletters, it should also be available to the shareholders. Always be mindful of who are investing alongside of you, and what are their motives?

Complaints concerning the cash flow statement center on the complexity of the reconciliation format. The concept of how changes in balance sheet accounts affect cash flow is confusing. The critics additionally argue that while the cash flow statement neatly ties together all the financial statements, and quantifies the cash flow activities from the major business functions of the company, it does not address the bigger picture of liquidity. Liquidity is a company’s ability to pay its bills on time.

Investors need to “draw the connecting dots,” and tie together a company’s credit lines, cash flow, and debt arrangements. Projecting cash flow will alert one, in advance, to an upcoming liquidity squeeze. Additionally, be sure to read the footnotes, and focus on whether or not a company can meet its upcoming financial obligations. Below is the cash flow statement for Medtronic.

Consolidated Statements of Cash Flows for Medtronic, Inc.
(Dollars in millions)

Medtronic, Inc.           
Statements of Cash Flows

Fiscal Yr.
2005

Fiscal Yr.
2004

Operating Activities:

 

 

 Net earnings

$1,803.9

$1,959.3

 Adjustments to reconcile to net cash:

 

 

     Depreciation and amortization

463.3

442.6

     IPR&D

 

41.1

     Special charges

654.4

(4.8)

     Tax benefit from stock awards

60.8

55.4

     Deferred income taxes

(142.5)

110.5

 Changes in op. assets & liabilities:

 

 

        Accounts receivable

(227.7)

(171.5)

        Inventories

(51.3)

127.6

        Prepaid expense & other assets

(107.3)

(97.4)

        A/P and accrued liabilities

423.2

326.1

        Other long-term liabilities

(57.4)

56.9

 Net cash provided by
 operating activities


2,819.4


2,845.8

 

 

 

Investing Activities:

 

 

 Acquisitions, net of cash acquired

(107.9)

(30.9)

 Purchase of intellectual property

(10.0)

 

 Additions to property, plant and eq.

(452.0)

(424.6)

 Sales & maturities of marketable sec.

807.5

1,473.2

 Purchases of marketable securities

(1,805.3)

(2,684.0)

 Other investing activities, net

(35.2)

15.5

 

 

 

 Net cash used in investing activities

(1,602.9)

(1,650.8)

 

Medtronic, Inc.          
Statements of Cash Flows

Fiscal Yr.
2005

Fiscal Yr.
2004

Financing Activities:

 

 

 Increase in short-term borrowings

90.0

(19.5)

 Payments on long-term debt

(1.8)

 

 Issuance of long-term debt

 

 

 Dividends to shareholders

(404.9)

(351.5)

 Repurchase of common stock

(511.0)

(880.5)

 Issuance of common stock

338.9

241.4

 Net cash used in financing activities

(488.8)

(1,010.1)

 

 

 

 Effect of exch. rate changes on cash & eq.

(89.2)

(61.3)

Net change in cash and cash equivalents

638.5

123.6

Cash and cash equiv. at beg. of period

1,593.7

1,470.1

Cash and cash equiv. at end of period

$ 2,232.2

$ 1,593.7

 

 

 

Supplemental Cash Flow Information

 

 

 Cash paid during the year for:

 

 

     Income taxes

$ 551.8

$ 490.9

     Interest

55.1

56.9

 

 

 

Cash Flow Statistics

 

 

Operating cash flow to sales:

 

 

Net sales

10,054.6

9,087.2

Net  cash  provided  by  operating activities   

2,819.4

2,845.8

Add back:

 

 

         IPR&D

 

41.1

         Special charges

654.4

(4.8)

Proforma operating cash flow

3,473.8

2,882.1

 

 

 

Operating cash flow to sales

34.55 %

31.72 %

 

 

 

Cash flow yield:

 

 

Net Cash from Operating Activities ÷

2,819.4

2,845.8

Net Income

1,803.9

1,959.3

Cash flow yield

1.6 times

1.5 times

Operating cash flow is a significant figure, as it determines how much money is available for: 1) future investments (cap x), 2) debt repayments or stock repurchases, and 3) dividends.

Lenders, however, seem to prefer EBITDA calculations.

Many investors ask what is EBITDA or EBIT.  First, EBITDA stands for earnings before interest, taxes, depreciation and amortization.  Naturally, EBIT stands for earnings before interest and taxes, also commonly referred to as operating income. Many bankers use these figures instead of cash flow, as a quick calculation of a company’s leverage capacity. It’s important for stock investors to understand this terminology, since most banking financial covenants are based on EBITDA or EBIT ratios.  Additionally, many businesses are valued using EBITDA or EBIT multiples.  For a more detailed analysis of EBITDA, refer to the cash flow analysis section of this book.
 

Medtronic, Inc.           
Debt to EBITDA Calculation

($ in millions)


Fiscal Yr.
2005


Fiscal Yr.

2004

Debt:

 

 

Short-term borrowings

$ 478.6

$ 2,358.2

Long-term debt

1,973.2

1.1

Interest bearing debt

2,451.8

2,359.3

 

 

 

EBITDA:

 

 

Earnings before income taxes

$ 2,543.5

$ 2,796.9

Interest (income) expense

(45.1)

(2.8)

Depreciation and amortization

463.3

442.6

IPR&D

 

41.1

Special charges

654.4

(4.8)

Proforma EBITDA

3,616.1

3,273.0

Debt to proforma EBITDA

.68 to 1

.72 to 1

 

 

 

 

 

 

EBITDA Margin:

 

 

Net sales

10,054.6

9,087.2

Proforma EBITDA

3,616.1

3,273.0

EBITDA Margin

35.96 %

36.02 %

Next review The Shareholders' Equity Statement

 

 

 

 

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