You have probably heard or read somewhere that cash is the lifeblood of any business. Without adequate cash, no business can survive and grow. Cash flows both into the business and out from the business. In the morning, a business might receive payments from customers, recorded as cash inflow; and in the afternoon make payments to suppliers, recorded as cash outflows.
Cash flows in and out of a business in three areas, which correspond to the three sections on a Statement of Cash Flows:
• Operating Activities
• Investing Activities
• Financing Activities
Note that investors do not view all cash inflow equally, as cash from the actual operations of the business is a better measure of fundamental soundness than cash generated from investing or financing.
For example, if a business is experiencing a cash crunch situation they may sell off some of what they own, which is considered an investing activity. Selling equipment, buildings, and land, may generate short-term cash, but it may not be a very sound idea for the future of the business. Extra cash from such investing activities can make the company’s real cash position look better than it actually is.
Similarly, a business can generate cash by borrowing or issuing additional shares. Again, in the short-term, cash is cash, but taking on excessive debt and continual share dilution are not hallmarks of a well-managed company. What investors want to see is consistent performance in cash flow from operating activities.
Okay, let us jump into the Statement of Cash Flows for our target company, Oil Search Limited, and see what story it has to tell. Here is the statement, which you can find on the OSH website. As a reminder, financial websites like thebull.com have links to corporate sites.
|Oil Search Limited
Statement of Cash Flows
For the Financial Year Ended 31 December 2009
|Cash Flows from Operating Activities
Receipts from Customers
Payments to Suppliers and Employees
Borrowing Costs Paid
Income Tax (Paid)/Refund
|Net Operating Cash Flows||21(b)||284,099||507,423|
|Cash Flows from Investing Activities
Payments for Property, Plant, and Equipment
Payments for Exploration and Evaluation Expenditure
Payments for Production Expenditure
Proceeds from State Back-In LNG
Proceeds from Sale of Property, Plant, and Equipment
Cash Inflow on Sale of Joint Venture Interests
|Net Investing Cash Flows||(382,151)||(234,894)|
|Cash Flows from Financing Activities
Proceeds from Underwriter of Dividend Reinvestment Plan (DRP)
Dividend Payments (Net of DRP)
Net Proceeds from Share Issues
Purchase of Treasury Shares
Loans to Related Entity
|Net Financing Cash Flows||851,201||(81,179)|
|Net (Decrease)/Increase in Cash and Cash Equivalents Held
Cash and Cash Equivalents at the Beginning of the Year
|Cash and Cash Equivalent at End of Year||21(a)||1,288,077||534,928|
We begin with a quick look at the all-important top line – cash from operating activities – and it is not a pretty picture. Receipts from customers dropped about 400 billion dollars from the previous year. However, if you have been following along as we looked at Oil Search’ other financial statements, you already know 2009 was a bad year for the energy industry, so the drop should not come as a surprise. Now some investors might skip to the end of the cash flow story – what was the total cash and cash equivalent at the end of the year – to get a final grade on the company’s cash flow performance. If you look at that number – US$ 1,288,077,000 compared to the prior year’s US$ 534,928,000, you might be tempted to stop searching and simply buy the shares.
A skeptical investor would want an explanation, as on the surface, the numbers simply do not add up. How can you generate significantly less cash from operations and end up with almost a three-fold increase in total cash at the end of the year?
The possible answers are right there on the statements. First, if you look at cash flow from investing activities you will see Oil Search did not raise any cash by selling off assets, which may be a good sign. The increase in total year-end cash came primarily from financing. There the numbers tell the story. Oil Search did go to the capital markets to borrow money. Instead, they raised needed cash through issuing additional shares. While share dilution is a nightmare to many existing investors, the intelligent investor knows raising money from new owners is preferable to taking on new lenders and more debt.
Some experts feel you should begin an analysis of the cash flow statement with the bottom line that shows the net change in cash and cash equivalents from year over year. For OSH, the number is 753,149. As a quick side note, in case you did not know, a cash equivalent is an asset that can be converted to cash quickly. Regardless of where you start, you get to the same place – OSH has a lot more cash at the end of this year than at the end of the previous year.
As is the case with much investing research, one possible answer raises additional questions. In the case of Oil Search, one wonders why the need for more cash? Is this accounting noise designed to make the shares more attractive to the investing public? Next week we will address that question as we venture into the rest of the OSH annual report – management discussion and the written overview of the company and its plans for the future.
In closing, you know the more you can compare the performance of a company on any metric with the performance of other companies the better you will be. Courtesy of Morningstar Australia and Yahoo Finance Australia, we put together the following table, comparing Oil Search to Woodside Petroleum and Santos Limited, two other companies in the ASX energy sector.
1 Year Growth Rate
|Total Cash Per Share
(MRQ- most recent quarter)