Free cash flow case study: Netflix

[@TheFinanceStoryteller]

Enjoyed this video? Then subscribe to the channel right now, and watch several more case studies of the balance sheet, income statement and cash flow statement for companies like Amazon, Facebook, Microsoft and Tesla kzbin.info/www/bejne/hnqciWiPl8qelac

[@astarpery6260]

Great video and very easy to understand because you break it down well. Would love more of these case studies.

[@TheFinanceStoryteller]

You're welcome, Leighan! I have 15 more case studies for you. I have done similar walk-throughs of balance sheet, income statement and cash flow statement of companies like Alphabet Inc (Google), Facebook, Microsoft, Tesla, Walmart, etc. See the "finance case studies" playlist: kzbin.info/www/bejne/hnqciWiPl8qelac Enjoy, and let me know what you think!

[@shikharsingal7630]

Another great video. Practical case studies and examples are great. “The maker of the video does not hold position and doesn’t even have a Netflix subscription” was hilarious

[@TheFinanceStoryteller]

Thank you very much, Shikhar! I make similar disclosures when I use Apple as an example in my videos. My daughters bug me that I refuse to buy and use Apple products (they themselves are big fans), but seem obsessed with that company when I make case studies for my KZbin channel. ;-)

[@venkat3029]

Hi what is positive cashflow and what is Negative Cashflow? Is that generate FCF ? Or Changes in percentage of Cashflows of every QOQ &YOY ? Or You explained Netflix example like that Negitive CF (Starting C - Ending C) ?

[@TheFinanceStoryteller]

Hello Venkatesh! With a complicated topic like cash flow, you need to keep things as simple as possible. Understand absolute amounts for one accounting period first, before doing any year-over-year comparisons. Positive cashflow = more cash coming in than going out. Negative cashflow = more cash going out than coming in. I love the topic of cash flow, so have a few suggestions of videos that I made relating to that. Cash flow statement explained: kzbin.info/www/bejne/o4ulm6Z_jtd_rK8 Cash flow forecast kzbin.info/www/bejne/joe6h2Seftici9U Free cash flow in the business plan kzbin.info/www/bejne/fHSTi4J6jKutptE

[@karthik007]

Okay they are right now reliant on debt to fund their growth due to negative free cash flow but I am wondering how are they going to pay their debt in future if it is continues be negative like this for a long time. It all seems like a spiral to me.

[@TheFinanceStoryteller]

Netflix free cash flow has improved since I made the video: $1.9B positive in 2020 (lots more viewers, fewer movie/series productions due to the pandemic) which enabled them to pay back some debt, and "just" 159 million dollars negative in 2021. The big question is indeed when and how are they consistently going to be generating positive free cash flow. Given the recent big drop in the share price, a lot of investors seem to be asking that question as well....

[@Jasonasked1233]

@@TheFinanceStoryteller It's simple. They're not

[@nataliadiaz4197]

Thank You, Sir, for this great video.

[@TheFinanceStoryteller]

Glad it was helpful! :-)

[@connorsims8756]

Your videos have helped me understand financial statements better than any other channel. Thank you and keep it up! You deserve way more views, but I think most people don't want to get this deep into the accounting nitty gritty.

[@TheFinanceStoryteller]

Thank you very much, Connor! Just reached 3 million cumulative views since the start of my channel (of which 2 million are from the last 12 months), so the pace is picking up! Please subscribe, and spread the word to friends and colleagues. Here's the link to a playlist of most of my financial statement case studies: kzbin.info/www/bejne/hnqciWiPl8qelac

[@samanthapaola7801]

I love your videos, thank you very much.

[@TheFinanceStoryteller]

So nice of you, Samantha! Happy to help.

[@waschbar4960]

Hello! I want to thank you for this great video

[@TheFinanceStoryteller]

You're welcome! Let me know what else you come up with in your research!

[@ChrissyDee3]

Hello - I am trying to build a cash flow forecast for digital content and have been searching how to reconcile amortization from IS to CF correctly and wondering how you handle showing itt at Netflix

[@TheFinanceStoryteller]

Hi Chrissy! I would say it would be the same reconciliation as with any other cash flow statement that uses the indirect format: start off with net income (that has depreciation and amortization taken into account), and then add back depreciation and amortization and other non-cash expenses, adjust for changes in working capital, in order to get to cash from operating activities. Here's my video from a few years ago on Alphabet Inc's cash flow statement: kzbin.info/www/bejne/oaCylZ1srLd9b68

[@user-ql3ws5uz1d]

Thank you for the video! It is very annoying to me that the accounting standards allow the core operating costs, such as the cost for purchasing content for Netflix, to amortize over the years as expenses in the income statement because companies are worried that a one-time huge expense will affect the net income figure grossly. I mean can't they just make things simpler : (

[@TheFinanceStoryteller]

I think that is related to the matching principle. Netlix' "streaming content assets" are treated the same way that a manufacturing company treats a machine. Buy it upfront (cash moving out), put it on the balance sheet as an asset, and then depreciate (tangible asset) / amortize (intangible asset) over its useful economic life.

[@ChrissyDee3]

@@TheFinanceStoryteller can you update this video or make a new Digital Content FCF statement with the new accounting standards under ASC 920? I’m finding great difficulty supporting my adjustments to cash flow with the intricacies of accrual timing and digital content amort rules

[@TheFinanceStoryteller]

Thank you for the suggestion, Chrissy! I might do that in the future. In the near term, I have a lot of other projects to take care of first.

[@Don-uh1eb]

Can I make a Discounted cash flow using negative free cash flows?

[@TheFinanceStoryteller]

If all values involved are negative, then there is no use. If one or a few are negative, and the rest is positive, then it could work. For my thoughts on discounted cash flow, see my WACC video: kzbin.info/www/bejne/Z4CQdZWqi9qYg9k

[@Don-uh1eb]

@@TheFinanceStoryteller Thank youu, can you please give an explanation of why there’s no use when the values are negative?

[@TheFinanceStoryteller]

If the expected future free cash flows are all negative, then their present value equivalents will also be negative, and the value of the company as a whole would be negative (you'd pay someone to take the shares off your hands).

[@convinth]

If 90% amortisation takes place within 4 years, then I still don't fully understand why free cash-flow (as defined here) is such a high negative figure. Perhaps it means that the company is attempting to grow so fast that it achieves economy of scale quickly making it harder for any competitors.

[@TheFinanceStoryteller]

Netflix has been adding a lot of their own "Netflix original" series in recent years. They pay cash to produce this content (cash outflow), capitalize this as content assets on the balance sheet, and then amortize based on viewing patterns. If you translate this to (simplified) journal entries, then you will see why free cash flow has been so highly negative (until 2020): Journal entry #1 Producing content (generating an intangible asset, and paying the scriptwriters, actors, production crew): Debit Content assets (balance sheet) Credit Cash (balance sheet) The above journal entry affects balance sheet and cash flow statement. Journal entry #2 Amortizing the assets when viewed Debit Amortization expense (income statement) Credit Accumulated amortization (content assets contra-account on the balance sheet) The above journal entry affects income statement and balance sheet, but NOT the cash flow statement. Related videos: amortization kzbin.info/www/bejne/mZqaY5SViN95mbM and contra accounts kzbin.info/www/bejne/n6nOlamFiZyNeqs

[@john8909]

What do you think about capitalizing customer acquisition cost for Netflix instead as OPEX. They have huge stickiness and paying subscribers which is their most important KPI. My reasoning is because customer acquisition cost fits the definition of capital expenditures.

[@TheFinanceStoryteller]

Hello John! I disagree with you. I would take the conservative approach and expense these when incurred. If you want to review this in detail, then I would suggest starting with the new revenue recognition accounting standards (ASC 606 for US-listed companies, IFRS 15 for companies listed outside the US). In addition, I know there is some specific accounting guidance in the US for cable TV companies, movie production companies, etc., that could clarify whether capitalization might be justifiable.

[@hcp0scratch]

FANTASTIC!!! TY!

[@TheFinanceStoryteller]

Glad you like it, Matt! Did you know that the Free Cash Flow of Netflix in 2020 actually ended up being a positive number? They can now pay down (some) debt from the free cash flow they have generated.

[@vikashbarnwal4840]

Hi friend

[@TheFinanceStoryteller]

Hello Vikash! Did you enjoy the new video?

[@vikashbarnwal4840]

Yes , friend As usual you have explained cash flow case in very easy way.

[@AceHardy]

💲

[@pavelhrivnak883]

I can understand that the investing cash-flow is negative because of "investment" into the content assets. What I do not get is why Netflix has negative operating cash-flows? The cash-inflow from revenue is upfront and growing like crazy, the cash out-flow from operating expenses is not a big deal relative to the revenue and the amortisation of content assets is a non-cash expense... So why negative operating cash-flows?

[@TheFinanceStoryteller]

Hello Pavel! That's a great follow-up question. Please note that the "additions to streaming content assets" are recorded in the cash flow statement in CFOA (I guess similar to a manufacturing company that would record a change in inventory there), and NOT in Capital Expenditures (CFIA). Netflix (like many other companies) uses the indirect method of cash flow reporting (i.e. starting off with net income, and then reconciling to CFOA). For 2019, the main items in there are: Net Income $1.9B Add back amortization of streaming content assets $9.2B (this is a non-cash expense) Additions to streaming content assets ($13.9B) Change in streaming content liabilites ($0.7B) Long list of other stuff - net $0.6B Total CFOA ($2.9B) By contrast, the CFIA section is fairly small (in number of items and monetary value): purchase of property and equipment ($253MM) and change in other assets ($134MM), total ($387MM). See also the cash flow statement in the 2019 Netflix annual report (10-K filing).

[@john8909]

The Finance Storyteller so the discrepancy between net income and operating cash flow is because “additions to streaming content assets” are recorded as operating cash outflow rather than as an investing outflow? And second why isn’t “additions to streaming content assets” shown in the income statement ????

[@pavelhrivnak883]

It does not seem correct to show investment in non-current content assets as operating cash-flows though... for me, it is an investing cash-outflow since it is going to generate cash inflows for 4 next years...

[@TheFinanceStoryteller]

@@john8909 Hello John! 1st question: correct. 2nd question: in the income statement you see the amortization of the streaming content assets (i.e. allocating them to expense over their lifetime). Taking the additions straight to expense in the income statement, rather than adding them to the balance sheet first and then amortizing would be incorrect from the matching standpoint.

[@john8909]

The Finance Storyteller thanks!!!!!!