Thread by @FincademyIn

Thread: Cash Flow Gimmick!

As we all know the Cash Flow Statement (CFS) shows the movement of cash in and from the company in a current period. However we need to have some eye for detail to check if there is anything unusual going on with the business.

Let us take an example of a company that is growing sales at a decent pace. usually it should have growing cash flows too at around same pace. However, What could go wrong?

So if a company focuses too much on growing it's topline (sales) in order to report growth in numbers, there are chances that it might not be able to efficiently collect money from it's receivables (debtors). i.e. It might have to offer extended credit to customers

in order to achieve higher sales. This is where you can detect such scenario in cash flow statement.

Let's see how.
Step 1: Take the sales figures for 5-7 years period.

Step 2: Go to cash flow statement and find an item named "Trade Receivables". This should be under Cash flow from operating activities. (If the figure for any year is negative, that means debtors have increased and cash is blocked)

Step 3: Check year on year and on 5-7 year basis if the company has blocked too much money in Trade receivable to achieve sales growth.

Example:

The above example is of Hero Motocorp Limited. 4 out of 6 years the company has managed to grow sales without offering extended credit to customers. In year ending 2020, The sales have gone down drastically however company was able to efficiently manage the receivables.

One way to ensure efficiency is to ensure the receivables don't outgrow the sales numbers.

Tip: Check for Bad debts in the Profit & Loss statement. If this number is increasing then it is a red flag that company is extending credit to bogus or untrustworthy customers.