Accounting and Cash Flows
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Accounting and Cash Flows

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With these understandings, we can now utilize concepts of the cash flows sheet and understand their relevance to businesses; in the same way we did for the income and balance sheets.

Just as we have analyzed revenue and profits, as well as assets and debt, we can look deeper into the realm of cash flows into the three major categories of cash flows. By creating these categories and observing how they change over the course of a company’s life cycle, we can find insightful information about the current stage of a company as well as what the future generally holds for it. As we have done for the last two statements, we will start with the case of Peloton, and transition into Netflix, Coca Cola, and lastly Toyota.

The Indicators

One of the most glaring indicators of Peloton being a young company is in the process from equity of their 2019 cash flows statement. As Peloton develops their status as a new, defining company in their niche industry, they are bound to develop a large cash process through increases in equity. Simply put, more people bought their product and they are collecting the proceeds as a result of these purchases. This also connects to the net cash used in operating activities, or activities involved in the process of creating and selling goods. As Peloton has more customers, they will end up spending more on manufacturing their products. We also see Peloton have a high stock-based compensation expense, which is the equity and company share that is given to employees. As cash is limited in young companies, this is a common form of payment that companies will administer as an alternative to high wages. We see this not only in Peloton, but many companies in the young growth stage.

Transitioning to a company a step higher in the company life-cycle, we can examine Netflix’s 2020 report in the same way. We can see through their high operating cash flow that Netflix is indeed making money through their business, and cements their status as a high growth company. Although this is true, we can see that a significant portion of their spending is dedicated to the creation of content; this makes sense, as the current peak of their popularity and company growth, they are the most committed to improving their service, retaining customers, and possibly alluring new customers. Their capital placed in investments is also significantly less, as their focus is not on generating more capital, but developing new content for their users; clearly, their content generates a greater return than investment in this case.

Now, the mature company: Coca Cola. Like Peloton, Coca Cola has a substantial amount of capital placed into stock-based compensation expenses. But what allows us to differentiate between companies if this metric is similar? What we need to understand is scope. Relative to their other placements of capital, this stock-based competition is an insignificant expense. Meanwhile, this same expense for Peloton is regarded as a larger portion of capital relative to the size of their other cash flows. We can also see that Coca Cola is overpaying for their listed debt; this is very common in mature-stage companies, as they are not able to handle debt better than a company in a younger stage of development. 

Lastly, Toyota. We can see that there is a significant amount of capital paid for deferred income tax. This is a common process for older companies, as they finish paying off taxes for previous years. We can also see that there is a high expense for dividend stocks. This makes sense for a mature company because the peak of their development is past, meaning that they are more likely to transition their stock into a dividend-based model versus a high-growth model to retain their stockholders.

Across the board, accounting is the backbone of most corporate financial analysis and valuation. To become good accountants ourselves, we need to understand how accountants think and operate. Accountants are extremely dynamic in nature, as companies are constantly in motion and changing. By sharpening our understanding of accounting, we can make much more informed investing decisions and seek out the crem de la crem of emerging companies.

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