This article covers:

• What is an Appendix 4C (or 5B)?

• Why is an Appendix 4C (or 5B) Required?

• How to Interpret a Quarterly Cash Flow Report

• Why are Quarterly Cash Flow Reports Important?

Selfwealth Premium members would be well aware that a large proportion of the Selfwealth community use their trading accounts to actively buy and sell small-cap stocks. Investing in shares at this end of the market comes with greater risk, however, some of today’s biggest companies once started life on the ASX as small-cap stocks.

If you need any convincing about the appeal of these stocks, here are three reasons ASX small-cap shares are exciting.

Nonetheless, as much as investors may want to spot the next ‘big’ stock while it is still trading in its infancy, it is arguably more important to be able to identify small-cap shares that look unlikely to achieve this feat to minimise your chances of a loss.

A company’s financial statements are a telling indicator when it comes to making such judgements, however, waiting for half-yearly or annual reports delays vital information. This is why investors should pay close attention to the ‘Appendix 4C’ documents released by small-cap shares.

What is an Appendix 4C?

This document is a quarterly cash flow report that details a company’s financial position through its cash flow. Sometimes it is also referred to as an ‘Appendix 5C’. It allows investors to gauge whether the business is meeting its objectives.

These financial updates are accompanied by an activity report, and they are published in January, April, July, and September, covering business operations from the most recent quarter.

Why is an Appendix 4C Required?

Quarterly cash flow reports are a common sighting in the small-cap sector and are required by the market operator.

Companies specified by the ASX, including mining, oil, and gas exploration entities, plus smaller businesses typically yet to turn a profit or achieve positive operating cash flow, must submit these reports to the market every three months as mentioned above.

The ability to interpret a quarterly cash flow report is a vital tool for any small-cap investor. Here’s what you should look out for.

How to Interpret a Quarterly Cash Flow Report

If you look at an Appendix 4C, you will notice a company’s cash flow is laid out across various activities as follows:

Cash Flow From Operating Activities

This section details the money that a business earns and spends in the normal course of its operations. Positive operating cash flow generally marks a transformational point for many small-cap companies, however, this usually takes extensive time. 

Take note, the receipts or cash flow coming into a business is typically different from what it earns in revenue. While you may still get a rough indication as to how a business is performing, the difference is due to accounting standards that establish revenue is recognised when it is recorded, and cash is recognised when it is received. 

Receipts will often vary from one sector to the next. For junior mining explorers, it is typical to see no receipts. For some tech or biotechnology shares, you may spot government grants, which reflects money coming into the business. 

One of the most important things is to track how a company spends its funds. That is, whether the costs are appropriate, consistent between quarters, or outpacing growth in receipts. If a company ‘burns’ through cash quickly, that will shape its future growth and funding prospects. You should also audit whether expenditure is in line with the company’s forecast in the prior quarterly cash flow report.

Cash Flow From Investing Activities

Where a business acquires or disposes of assets that are integral to its operations, all associated cash flow will be displayed in this section of a quarterly cash flow report. Acquisitions and disposals may include mining tenements, projects, IP, physical assets, or other businesses.

If a company has sufficient capital to fund its acquisitions, a cash outflow from investing activities should not necessarily raise a red flag in its own right.

Cash Flow From Financing Activities

When it comes to funding operations, the market will typically favour small-cap stocks that use existing cash reserves in place of debt or new equity. With that said, there are instances where these forms of funding have a distinct benefit, particularly if there are immediate opportunities available to fund growth. 

In any case, investors should pay attention to the details of this section to establish whether a company is dependent on debt or issuing financial instruments in order to stay afloat. This could be the sign of an unsustainable business, or at least one that is taking longer to grow than management may have expected, especially if cash flow from operating activities is not showing growth.

Net Change and Reconciliation of Cash and Cash Equivalents

These two sections provide a snapshot as to the overall change in cash and cash equivalents across the quarter. This will include cash gained from, or used in the three areas mentioned above – operating activities, investing activities, and financing activities. The reconciliation statement breaks this down accordingly.

It is not uncommon to see companies holding call deposits or bank overdrafts as opposed to bank balances. The key thing here to look at is whether the company has sufficient funds to at least sustain current operations for subsequent quarters, if not ramp up operations in pursuit of growth.

Payments to Related Parties of the Entity and Their Associates

In this section, you will find details on payments that have been extended to directors or related entities.

These payments should be commensurate with your expectations as to the size and performance of the business. If you have previously referred to the company’s prospectus or annual report for information on director salaries and rewards, the amounts should not come as a surprise.

Financing Facilities

An often overlooked section of the Appendix 4C, here you can understand what debt funding the company currently has, and the associated terms. An important consideration is the interest rate applicable to any financing, as these costs will be incurred as an outgoing payment as part of the cash flow from operating activities. 

The column titled ‘total facility amount’ illustrates the size of any debt the company has taken out. The right-hand column, titled ‘amount drawn at quarter end’, indicates how much of that funding has been used. Also shown is how much debt remains available. 

Estimated Cash Available for Future Operating Activities

This is one of the most important sections of an Appendix 4C or 5B, yet many investors don’t read this far into the report.

In this section, a company is required to provide a forecast of a cash ‘runway’ for its operations based on the total cash and funding it has on hand, plus the operating cash flow from the most recent quarter.

Remember, last quarter’s operating cash flow could vary significantly in the coming quarter, so the more cash at hand, the less likely it is the company will need to raise money and dilute existing shareholders. If there is a shortfall, you may also want to independently review your own calculations against the company’s explanation.

Why are Quarterly Cash Flow Reports Important?

Investing in shares requires extensive due diligence and insight into a company’s operations. ‘Voluntary’ announcements provided by a business give investors the means to stay informed as a company progresses towards its goals. However, few documents provide a more transparent and honest account of the company’s likelihood to achieve those objectives than the quarterly cash flow report. 

An Appendix 4C or 5B report will detail how a company manages its cash flow, while also allowing you to form a judgement on the growth prospects of that stock. Since small-cap stocks are inherently more risky, illiquid, and volatile compared with mature businesses that are cash flow positive, the quarterly cash flow report is one of the most important announcements that you should monitor every quarter if you intend to buy or sell small-cap stocks.