Hello, I'm Professor Brian Bushee. Welcome back. In this video, we're going to end our week looking at cash flows with a look at the 3M Company cash flow statement. We're going to take a look at their actual statement plus the supplemental disclosures about the statement footnotes, and the discussion of the cash flow statement in their management discussion and analysis or MD&A section. Let's get started. 3M statement of cash flows is on page 51 of their annual report. First thing I like to look at is this breakdown of operating, investing and financing activities to see what kind of stage or life cycle the company is in. So if 3M throws off about 5 billion of cash operations every year, it's pretty steady. They have cash outflows of from investing activities of about 2.6 billion every year and they also have net financing cash outflows of about $2 billion other than a blip in 2011. So, this is the classic mature company profile. You've got products that are essentially cash cows. They're just throwing off cash, things like Post-It notes and Scotch Tape, things that we can't do without. They're still reinvesting a moderate amount back into the company, back into long-term assets and we'll look at this more in a second and they are. Net cash outflows for financing. So they don't have to borrow, they don't have to raise money to fund their operations for their investments anymore. Instead, their operations are able to fund all of their investing activities and still throw off some cash that they can use to pay off debt or repurchase equity or pay dividends. So, just to get some more insight into this. One thing that's often good to look at is comparing depreciation to purchases of property, plant and equipment. Again, it's very rough. But if you view depreciation as using up your fixed assets, capital expenditure is obviously, acquiring new ones. It looks like 3M's at about replacement level. So they are investing a lot in new PP&E, but it's sort of replacing the things that they're using up. They do have though, some active acquisitions. So, about a billion of so in 2012 and then there's a lot of activity with marketable securities. So they bought about 5.5 billion of marketable securities, but then they sold or had those almost all mature within 2012. So, I think what happens is 3M is throwing off a lot of cash. If they don't immediately have an acquisition in mind or immediately have purchase of property, plant and equipment, they plow it into marketable securities and investments. And then when those opportunities to make an acquisition were by PP&E come, they liquidate the marketable securities and use that to go out and make their acquisitions. So, it's almost like they're serving as their own bank by buying these marketable securities. Holding their cash, getting some return. Waiting until they can invest it. And then in the financing section, we see a lot of the financing cash out flows purchase of treasury stock. That's probably for stock options and then there is a big dividend that they pay to shareholders, which again is another example oftentimes of a mature company that if you don't have a full set of investments that you can put all your cash back in to, you may as well just pay it back to your shareholders and let them reinvest it somewhere. I think you're ready to do these kinds of life cycle or growth analyses on your own. So, here's what I want you to do. After the video's over, go on the internet. Find a firm that you're interested in. Take a look at their cash flow statement and see what you can learn by looking at the company's operating investing, and financing cash flows. Now, let's dig in to the operating section a bit more. So we start with net income, ignore the non controlling interest stuff for now and just view it as net income. Nice steady growth in net income, indicating that they are consistently able to price their products enough to cover the cost of running the business. And typical of a mature company, you have this steady profitability. That steady profitability turns into steady cash flows. So very mature, well-performing, humming along nicely company. One of the big discrepancies between net income and net cash, and operations is decrease, and amortization. Now, remember that's not a source of cash even though it looks like it here. Remember, depreciation reduces net income. It's non-cash, so we have to add it back to get to cash from operations. Fairly big number for 3M, because it does a lot of manufacturing and manufacturing companies tend to have high depreciation and amortization, then we have a number of other non-cash expenses. So things like pension, stock-based compensation and we have differed taxes and excess tax benefits. So first, the pension and post-retirement contribution, stock-based compensation. These are things we recognize as expenses now which means they're part of net income, but the cash is either paid in the future as this the case for pension and post-retirement benefits or the cash isn't really paid as it is for stock-based compensation, although part of it is you're buying back treasury stock to use the satisfying options. But any case, there's no cash flow this period for these expenses and we'll talk more about the stock-based compensation later on. The pensions and post-retirements, that's beyond the scope of this course. You'll have to come and take my course at Wharton, my elective to seem more on pensions and post-retirements. The deferred taxes. Well, obviously, get to later in the class. So then, we get to the section on changes in assets and liabilities. These are the changes in working capital and what we see is the big chunk here are accounts receivable, and inventory are negative. So, lets think about what that means. Negative number on the operating cash flow under the indirect method means that these amounts must be going up on the balance sheet. Accounts receivables goes up as a non-cash asset. To stay in balance, we have to subtract it on the cash flow statement. And yes, even though you can't see it, I am doing up and down arrows with my hand. Inventories go up on the balance sheet, non-cash asset going up. We have to subtract that on the cash flow statement. Accounts payable is also going up. Now remember, that's a liability. So if accounts payable, a liability increases, it's on the other side of the balance sheet equation, we have to increase it on the cash flow statement. So, these could represent either good or bad news. Bad news scenario would be our customers are not paying us. We're having trouble selling our inventory. We're having to stretch our payables. That's probably not the case here, given the nice growth and property period that's going on. And so more likely, story is, it's still growing company. So during the year where making a lot of credit sales at the end of the period, we were building inventory and anticipation of future sales. We are getting more raw materials at the end of the year in anticipation of production. And so based on other things I've seen, it probably is a good news scenario that this is representing growth and working capital rather than bad news where you can't collect receivables and you can't get rid of your inventories. So overall from the face of the statement, it looks like a mature company that still has some growth potential. Now, we're going to look at some other sections to try to get some additional information about what's going on with cash flows. And yes, while you're looking at those cash flows statements that you downloaded from the internet, you should also take a close look at the operating section. Look at net income. Look at cash of operations and look at all the things that cause differences between the two to see what kind of items that you would have questions about or want to learn more about to understand why the company's net income is different from its cash flow. Now jump ahead to page 69 where we have footnote 6, which is Supplemental Cash Flow Information. So if you remember back to the first video of the week, I said that there has to be a disclosure of cash taxes paid and cash interest payments. And as we talked about in, I think the second to the last video, that disclosures there. So if people want to remove cash interest and cash taxes from operating cash flow, they have the number. So in this footnote, we see the cash taxes and the cash interest. So if you want to start with the cash operations and the cash flow statement in terms of doing some kind of evaluation to measure operating cash flow, but you don't want tax or interest in there, you can pull those numbers out using this disclosure. One last section to look at related to cash flows is in the management discussion analysis, which is on page 36. Remember, this is the MD&A is the section where 3M management is suppose to supply their own narrative to explain what happen during the year. So, it will give us more insight into some of the numbers we saw on the cash flow statement. They repeat their operating section and talk about what happen in terms of their cash flows during the year. The big reason for the year on year increase in cash flows is net income went up. They do know that accounts receivable, inventories and accounts payable increased by 312 million compared to increases of 484 last year, but they t really don't talk much about what happened with that. Then at the bottom of the page, they disclosed free cash flow. And as I said a couple of videos ago, this a voluntary disclosure. Notice it's labelled as a non-GAAP measure. That means that there's no requirement by the SEC or the FASB to provide this measure, which also means there's no standardization. Companies can define this measure however they want. And when they do that, they have to alert investors and analysts that this is a non-GAAP measure. So, it's not standardized. So remember, free cash flow's supposed to be operating cash flow minus investment in the future. So we've got net cash operations from the cash flow statement as 3M's operating cash flow and then these purchase PP&E as their measure of investment in the future, investing a new property plan equipment which gives them a pretty high free cash flow and there's actually a pretty good definition. I've seen a lot worst, but this is a pretty good definition of free cash flow. But again, before you would use this number, you want to make sure you know it's in the definition and that you're comfortable with it. On the next page, we have cash from investing activities and what they've done here is they've nettled all the markable securities action into a small number. So instead of showing on the face the 5 billion they bought and then the almost 5 billion they sold, they just show a net number. So, it really highlights that the big drivers of cash out flows were purchases of PP&E and acquisitions. And they tell you that PP&E is expanding manufacturing capacity in key growth markets, especially international like China, Turkey and Poland. And so, we can see that they do still have growth opportunities and a lot of those growth opportunities seem to be international. For acquisitions, they refer us to note two. You can go there and look, I'm probably not going to jump ahead and look at that. And then finally, they talk about cash flows from financing activities. So remember the big chunks were proceeds from, I'm sorry, purchase of treasury stock. And the treasury stock, they say is for stock-based compensation. Now, we'll talk about these later in the course. But basically, stock-based compensation is where you will award your employees, either stock options or stock grants. You could either issue new stock to satisfy that or what most companies do is they just buy back their own stock and then either sell it to employees or give it to employees under these stock-based ownership plans, composition plans and then the other big chunk here is dividends to stockholders. 3M has paid dividends since 1916. So, we're almost on 100 years of dividends. And again, just consistent with companies that are very mature products. Throwing off a lot of cash. One thing they tend do is they start paying dividends. 3M started pretty early, I'm not sure it was Post-It Notes in 1916 and the thing about dividends is they tend to be sticky. Once you start paying them, you always want to keep paying them. If you ever cut them, it would be viewed by the market as bad news. So, that's where we find all the cash flow information in the annual report and that's going to wrap it up for our week on cash list statements. Hey, I was going to say that. [LAUGH] This does wrap up our week long look at the cash flow statement. I know it was difficult and there were some parts that didn't probably make sense right off the bat, but the cash flow statement is a very important statement and we are going to be seeing it again and again and again as we look at more advanced topics. And the more you see it, the more you'll get the hang of it. I'll see you next time.
