netflix financial analysis This is a topic that many people are looking for. thetruthaboutdow.org is a channel providing useful information about learning, life, digital marketing and online courses …. it will help you have an overview and solid multi-faceted knowledge . Today, thetruthaboutdow.org would like to introduce to you Netflix s Cash Flow Problem. Following along are instructions in the video below:
“Lot of investors really like the company netflix and the reason is that it showed showed really strong growth in terms of the number of subscribers in year after year company s revenue continues to increase. However netflix is a very serious cashflow problem so if you look at their statement of cash flows and you take a look at the cash flow from operating activities you see that netflix actually in its early years netflix was cashflow positive so it was bringing in more cash from its subscriptions and so forth then it was spending so remember cash flow from operating activities is one of the three main line items on the statement of cash flow a cash flow from operating activities cash flow from investing activities and cash flow from financing so cash flow from operating activities from the core business of selling subscriptions and netflix has actually turned negative over the past few years. Netflix is actually spending more cash. They are burning cash on their operating activities.
So how does the company continue to be financed when it has that well you re gonna go to cash flow from financing activities they re gonna borrow or they re gonna issue stock and that s how netflix does not run out of cash even though they ve had negative cash flow from operating activities multiple years in a row. They have not run out of cash because they begin to begun to borrow and if you look at their debt to equity ratio. You see that in the early years of netflix. They didn t have any debt and then over time they took on some debt and here s during the great recession.
Yeah okay so we got during that time you could see oh well there was a recession. I could see where they would take on some debt and then the debt came down. But then it went back up it went back up over the past few years netflix has become more and more leveraged okay so they re just borrowing more and more money and if we were to take a look at the trend of debt instead of the debt equity ratio. We take a look at the debt.
It was basically zero in their early years and then now we see look at it s like a rollercoaster with that first hump that rollercoaster takes. So they re getting more and more debt that they re having to take on and you say well why is netflix keep borrowing like what what is it that is causing them to to borrow so much money so basically what it is if you take a look at their cash flow capex ratio. They don t they can t any of their growth. So they re getting more and more subscribers.
There s game more more and they re producing more and more content. But they can t fund that growth from the operating cash flow. Because as we saw before for the past few years operating cash flow has actually been negative okay so if you don t have any operating cash flow..
Then you have to fund that growth some other way and what they re doing is they re borrowing so they re borrowing money and you say well what do they need the money for we ll remember that netflix is primarily streaming. They originally started out as dvd by mail. But around 2011. They shifted their focus to primarily streaming dvd.
By mail is not the main focus of the company okay so with streaming. What they have to do is produce content and they can license that content that s what they did mainly in the early years they would license content from movie studios or tv networks. They would pay them to be able to show their content. But then as you know probably netflix has begun to produce its own content.
So the production of content making their own movies making their own shows orange is the new black and so forth that costs money so as they get more and more subscribers and the number of subscribers grow that the subscribers want content. Okay. They want new shows that s why they re coming to netflix and so netflix needs to fund this growth somehow it needs to pay for the licensing. And then the production of content.
And it doesn t have positive operating cash flow. So it s having to fund the growth by borrowing so they re just borrowing more and more money and they re becoming more and more leveraged and you see that that s actually why we see that the free cash flow of netflix. Which is just a cash flow from operating activities. But then you subtract capital expenditures.
If you look at a free cash flow. It has basically fallen off a cliff. So from 2014..
Onwards free cash flow has dropped precipitously in the main reason that netflix is free cash flow is negative as is because of this costs the license in produced content. If you re actually if you re curious the way the netflix accounts for this what they do is the cost to license or produce content they make it an asset. Okay so that s called capitalization they make it an asset. Let s say they spend a million dollars on a show they an asset and then they expense it overtime so if they say okay well this show.
We re gonna show it for five years okay so then they would say okay two hundred thousand dollars of expense every year for five years and that that s why actually on paper. The company is profitable. So they show a profit but their cash flow negative. And so they would take this million and they would spread it over five years so they ve capitalized the asset in the expense.
It over time and we call this they call this amortization. So these amortized costs. Where do they end up on the income statement. Well you ll see them in an account called cost of revenue.
So cost of revenue. Is is basically don t confuse this with cost a good soul because remember netflix does not sell a physical product. But cost of revenue. Do you think that is the cost of generating revenue and for netflix again that s licensing and producing content.
So licensing and producing content as they amortize those costs in the example below. We set a million over over five years. So two hundred thousand that two hundred thousand would show up in this account cost of revenue now cost of revenue is a very significant expense for for netflix..
And you see at one point. It was basically as a percentage of their revenue. If we think about that in terms of scaling it it was taking up at one point more than seventy percent of their revenue in the early years. It was just about a third so about a third of their revenues that the money they brought in went to this cost of revenue of licensing content and so forth.
But then over time over time they start producing more and more of their own content. Because licensing costs were going up as demand for licensing for content. Went up more and more yet hulu. Different people wanting content.
So the prices went up and so they started saying well we ll produce our own content. But that s expensive as well and so we see that overtime cost of revenue became more and more a significant expense and now we look at about you know sixty three percent of the revenue. So if netflix brings in a hundred dollars of revenue from subscriptions 63 of that is going to go toward paying for the movie think about the content. Okay these amortize costs and so base.
They have a very expensive business. There are high fixed costs. There are high fixed costs associated with the content. Okay.
It s very expensive to be able to have all the different shows that they produce right they have a lot of netflix. Originals and then they license a lot of shows so they have so many different shows that you can watch on netflix and there s a very high fixed class and you say well how could this company ever make any money how are they ever going to make any money and and be cashflow positive like why would investors keep investing and so forth well one nice thing about netflix is even though they have these high fixed costs. They re very low..
They have very low marginal costs and when i say marginal costs. I mean if there s one new subscriber right now signs up for netflix it costs netflix almost nothing to serve that new subscriber. Because they can just watch the same content that everybody else was watching they ve already incurred those fixed costs to get all the content. So no matter.
How many new subscribers they add they re basically the cost of each additional subscriber is not very much so they have these very high fixed costs of content. But netflix is basically a company is built to be scaled and they ve they ve grown significantly. But they apparently haven t grown fast enough because their free cash flow is actually getting more negative. Even though they grow and add more and more subscribers.
They re not growing fast enough. They re not reaching scale fast enough because their cash flow. Position. Is is actually getting worse and so.
But ultimately the wake netflix. If there is a path forward to them being cashflow positive and being a very successful company in the long run. What it is is they have to reach such a scale. They have so many users that they re taking advantage of this fact that there s a low marginal cost of serving each additional user and then even in spite of the fact that they have these high fixed costs of licensing and producing content that would be the path forward to them actually having positive.
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