Cash: where does it go? Where does it come from?

A recent Globe and Mail article on Thompson Creek Metals Co (TCM) caught my eye.  TCM just finished raising some debt in the market to help fund their operations.  That by itself is not really that interesting – businesses raise debt financing every day of the week.  What I found interesting was the rate of interest that TCM had to offer investors to make this debt marketable – about 14%!  Let’s put this in context: bank mortgage rates are hovering between 3% and 4%.  Credit card debt is somewhere around 20%.

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Interest rates are a pretty good measure of risk.  Mortgages are generally low rate because they are secured by a substantial asset (your house) and the approval process is usually pretty thorough (ignoring the housing disaster in the US in the past five years).  Credit card debt is unsecured and pretty much anyone breathing can get a credit card these days.  So TCM’s projected interest rate of 14% is somewhere in the middle – why do I think its interesting?  Just 18 months ago (May 2011), TCM also went to the debt market and raised $350M.  That debt was initially issued to yield ~7.3%.  So why has TCM’s cost of capital (think “interest rate”) jumped so much in 18 months?  Two key factors: (1) their main product is not selling well and (2) they are bleeding cash.  It turns out that financial statements demonstrate this very well, primarily the Statement of Cash Flows.

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The Statement of Cash Flows is the “ugly duckling” of financial statements and generally plays second or third fiddle to the Balance Sheet and the Income Statement.  The purpose of the Statement of Cash Flows (SCF) is to tell the reader where cash has come from and where it is being used.  There are three main categories of items on the SCF: operations, investing, and financing.  Operations is the day-to-day business portion; proceeds from selling product and services less the cash required to pay all the business costs like purchasing inventory and paying for wages.  Investing activities are generally related to expanding the business’ assets (new mines, new dump trucks) or replacing those items.  Financing activities relate to raising new money from debt or from issuing shares or repaying debt or shareholders.  The table below summarizes TCM’s SCF (in millions US$) for the past three years:

  2011 2010 2009
Operations 202.7 157.4 105.9
Investing (716.4) (242.6) (412.6)
Financing 495.9 236.0 200.7

The SCF tells a pretty clear story – TCM is in a rapid expansion period.  They have spent over $1.3 Billion on new projects and new expansion in the past three years.  Since their current operations have only generated cash flow of $466 Million, they are scrambling to raise the remainder of the required cash.  In 2009 they issued new shares for $200 million.  In 2010 they raised $236 million mainly from an arrangement to sell future gold production (the “Gold Stream Arrangement”).  In 2011 they raised the majority of the total financing of $495 million from the issuance of the debt mentioned above, $350 M at ~ 7%.  

The picture painted by the SCF is a common story for start-up businesses.  They generally don’t produce much (or any) cash from operations, they require substantial amounts of new assets (negative cash flow from investing activities), so they end up raising new financing from debt or equity investors.  At some point though the business needs to reach a sustainable point where the cash flow from operations is sufficient to fund the required investing activities and start to repay financing activities.  As the story around TCM indicates, investors and management hope to reach that sustainable point before all sources of financing dry up.

I am a firm believer that the Statement of Cash Flows should not be the “ugly duck” and in fact should be the first financial statement that readers turn to.  Rare is the case that the SCF doesn’t tell a very accurate story of the firm simply by looking at the subtotals for the three main sections.  I encourage you to find a set of financial statements for a company you are interested in and create a table like the one above.  There are some common patterns for successful businesses, for new businesses, and for businesses that are a breathe away from bankruptcy.  What does the data from the SCF say about the company you were interested in?

Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

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