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.qxd 3/13/07 9:58 AM Page 69Looking under the Hood 69Cash from Operating Activities(in Millions of Dollars)* March 31, 2006 March 31, 2005Net income $275.1 $450.1Depreciation and amortization 261.0 192.0Changes in operating working capital (9.1) (81.4)Deferred income tax provision (80.4) 11.1Net losses on asset dispositions 63.9 3.5Equity company s earnings in excess (37.7) (33.6)of dividends paidPost-retirement benefits 3.3 29.0Other 42.8 37.7Total cash provided by operations 518.9 608.4*Actual filing from Kimberly-Clark.FIGURE 2.4 Cash from Operationspaid for.If inventory is paid for with credit, there is more cashavailable, and vice versa.When assets are sold, it impacts the cash flow statement; other-wise it isn t factored at all.Since assets begin to depreciate the mo-ment they are purchased (think of your car), they are sold at a loss.Other lines under Operating Activities are self-evident.Thetally gives us cash provided (or used) by operations.When cashfrom operations declines from one comparable period to the next, it is aserious red flag.INVESTMENT ACTIVITIES Investment activities measure how a com-pany uses its cash to generate future cash (see Figure 2.5).Essen-tially a company will invest cash into investments designed togenerate future sales, or in investments that will generate cash in-flows in the form of dividends and note payments.Capital spending represents larger, long-term investments such asa building or plant from which the company believes it will beable to produce more goods and therefore more sales and profits.I mentioned free cash flow earlier, and this is where you get tocalculate this all-important metric.Cash from operating activitiesminus capital spending gives you free cash flow.This is the real ccc_payne_041-074_ch02.qxd 3/13/07 9:58 AM Page 7070 BE SMARTInvestment Activities (in Millions of Dollars) March 31, 2006 March 31, 2005Capital spending (179.1) (108.9)Proceeds from sales of investments 8.5 10.5Net decrease (increase) in time deposits 32.6 (17.4)Investments in marketable securities (7.1) Other 1.4 (12.1)Total cash used for investing (143.7) (127.9)FIGURE 2.5 Investment Activitiesbottom line.We ve taken earnings and made adjustments forworking capital, taxes, and other investments.Many Wall Streetanalysts consider the trends in free cash flow to be the holy grail ofa company s value.Obviously it s important, but I think cash fromoperating activities is more important because I think businessesshould be rewarded for investing in the business.However, thatdoesn t discount free cash flow, which doesn t take into accountthe service payment obligations for debt.I simply think of onemeasure as 1 and the other as 1A. Other components of investment activities include proceedsfrom sales of investments, net decrease (or increase) in time de-posits, and investments in marketable securities.FINANCING ACTIVITIES This portion of the cash flow statement re-flects the flow of monies raised and monies owed to investors.Monies raised are called cash in whereas monies paid out in divi-dends or the repurchase of stock as well as payments of notes arecalled cash out.See Figure 2.6 for an example.In addition to the income statement, balance sheet, and cashflow statement, financial filings offer details on the sources of rev-enue, either through various business segments or geographically,or both.Moreover, these filings also include management s discus-sion and analysis of financial condition and results of operations(MD&A).MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS Although it only seems like the SEC ccc_payne_041-074_ch02.qxd 3/13/07 9:58 AM Page 71Looking under the Hood 71Financial Activities March 31, 2006 March 31, 2005Cash dividends paid (208.6) (194.2)Net (decrease) increase in short-term debt (25.7) 301.5Proceeds from issuance of long-term debt 2.2 Repayments of long-term debt (16.5) (84.5)Proceeds from exercise of stock options 63.2 67.0Acquisitions of common stock for treasury (152.2) (321.9)Other (15.6) (3.3)Total cash used for financing (353.2) (235.4)Effect of exchange rate changes on cash 3.2 (5.6)and cash equivalentsIncrease in cash and cash equivalents 25.2 239.5Cash and cash equivalents, beginning of period 364.0 594.0Cash and cash equivalents, end of period $389.2 $833.0FIGURE 2.6 Financial Activitieshas demanded accountability from management in recent years,the MD&A originated in 1968 and was expanded in 1980 and 1989.As the name implies, this is a wide-ranging discussion of financialstatements that covers capital, liquidity, cash flow, and salestrends.Between 2000 and 2004 a ton of companies opted not to giveearnings guidance; many cited a lack of so-called visibility.The re-ality was that most had no clue, and those that did have a cluedidn t want to share the dismal news.I m always concerned whenmanagement can t see as far as the current quarter or doesn t have ccc_payne_041-074_ch02.qxd 3/13/07 9:58 AM Page 7272 BE SMARTthe nerve to toss out a number, even if it s frowned upon by theStreet.I strongly urge you to listen to the conference calls of the compa-nies in your portfolio.Most of the calls follow the same pattern:Management will recite verbatim the press release portion of theearnings release and bring a bunch of people on stage to go overthe numbers that are also in the filing.If you are pressed for timeor prone to suicide when boredom sets in, one shortcut would beto skip straight to the question-and-answer period.Although WallStreet analysts should do a much better job than they do, thesemen and women know the industry (and company) better thanyou do, so piggyback off their questions during the Q&A session,which is the last portion of the call.Make sure you ve gonethrough the filings and the worksheets in the next chapter beforelistening to the call, to make sure your questions are asked and an-swered, too.Summary of FundamentalsUnderstanding fundamentals is the first step toward developing aportfolio that allows you to sleep at night
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