Module 3 Fundamental Analysis

Chapter 8

The Cash Flow statement

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8.1 – Overview

The Cash flow statement is a very important financial statement, as it reveals how much cash the company is actually generating. Is this information not revealed in the P&L statement you may think? Well, the answer is both a yes and a no.

Consider the following scenario.

Assume a simple coffee shop selling coffee and short eats. All the sales the shop does is mostly on cash basis, meaning if a customer wants to have a cup of coffee and a snack, he needs to have enough money to buy what he wants. Going by that on a particular day, assume the shop manages to sell Rs.2,500/- worth of coffee and Rs.3,000/- worth of snacks. It is evident that the shop’s income is Rs.5,500/- for that day. Rs.5,500/- is reported as revenues in P&L, and there is no ambiguity with this.

Now think about another business that sells laptops. For sake of simplicity, let us assume that the shop sells only 1 type of laptop at a standard fixed rate of Rs.25,000/- per laptop. Assume on a certain day, the shop manages to sells 20 such laptops. Clearly the revenue for the shop would be Rs.25,000 x 20 = Rs.500,000/-. But what if 5 of the 20 laptops were sold on credit? A credit sale is when the customer takes the product today but pays the cash at a later point in time. In this situation here is how the numbers would look:

Cash sale: 15 * 25000 = Rs.375,000/-

Credit sale: 5 * 25000 = Rs.125,000/-

Total sales: Rs.500,000/-

If this shop was to show its total revenue in its P&L statement, you would just see a revenue of Rs.500,000/- which may seem good on the face of it. However, how much of this Rs.500,000/- is actually present in the company’s bank account is not clear. What if this company had a loan of Rs.400,000/- that had to be repaid back urgently? Even though the company has a sale of Rs.500,000 it has only Rs.375,000/- in its account. This means the company has a cash crunch, as it cannot meet its debt obligations.

The cash flow statement captures this information. A statement of cash flows should be presented as an integral part of an entity’s financial statements. Hence in this context evaluation of the cash flow statement is highly critical as it reveals amongst other things, the true cash position of the company.

To sum up, every company’s financial performance is not so much dependent on the profits earned during a period, but more realistically on liquidity or cash flows.
M3-Ch8-title

8.2 – Activities of a company

Before we go ahead to understand the cash flow statement, it is important to understand ‘the activities’ of a company. If you think about a company and the various business activities it undertakes, you will realize that the company’s activities can be classified under one of the three standard baskets. We will understand this in terms of an example.

Imagine a business, maybe a very well established fitness center (Talwalkars, Gold’s Gym etc) with a sound corporate structure. What are the typical business activities you think a fitness center would have? Let me go ahead and list a few business activities:

  1. Display advertisements to attract new customers
  2. Hire fitness instructors to help clients in their fitness workout
  3. Buy new fitness equipments to replace worn out equipments
  4. Seek short term loan from bankers
  5. Issue a certificate of deposit for raising funds
  6. Issue new shares to a few known friends to raise fresh capital for expansion (also called preferential allotment)
  7. Invest in a startup company working towards innovative fitness regimes
  8. Park excess money (if any) in fixed deposits
  9. Invest in a building coming up in the neighborhood, for opening a new fitness center sometime in the future
  10. Upgrade the sound system for a better workout experience

As you can see the above listed business activities are quite diverse however they are all related to the business. We can classify these activities as:

  1. Operational activities (OA): Activities that are directly related to the daily core business operations are called operational activities. Typical operating activities include sales, marketing, manufacturing, technology upgrade, resource hiring etc.
  2. Investing activities (IA): Activities pertaining to investments that the company makes with an intention of reaping benefits at a later stage. Examples include parking money in interest bearing instruments, investing in equity shares, investing in land, property, plant and equipment, intangibles and other non current assets etc
  3. Financing activities (FA): Activities pertaining to all financial transactions of the company such as distributing dividends, paying interest to service debt, raising fresh debt, issuing corporate bonds etc

All activities a legitimate company performs can be classified under one of the above three mentioned categories.

Keeping the above three activities in perspective, we will now classify each of the above mentioned activities into one of the three categories /baskets.

  1. Display advertisements to attract new customers – OA
  2. Hire fitness instructors to help customers with their fitness workout – OA
  3. Buy new fitness equipment to replace worn out equipments – OA
  4. Seek a short term loan from bankers – FA
  5. Issue a certificate of deposit (CD) for raising funds – FA
  6. Issue new shares to few known friends to raise fresh capital for expansion (also called preferential allotment) – FA
  7. Invest in a startup company working towards innovative fitness regimes – IA
  8. Park excess money (if any) in fixed deposit – IA
  9. Invest in a building coming up in the neighborhood for opening a new fitness center sometime in the future – IA
  10. Upgrade the sound system for better workout experience- OA

Now think about the cash moving in and out of the company and its impact on the cash balance. Each activity that the company undertakes has an impact on cash. For example “Upgrade the sound system for a better workout experience” means the company has to pay money towards the purchase of a new sound system, hence the cash balance decreases. Also, it is interesting to note that the new sound system itself will be treated as a company asset.

Keeping this in perspective, we will now understand for the example given above how the various activities listed would impact the cash balance and how would it impact the balance sheet.

Activity No Activity Type Rational Cash Balance On Balance Sheet
01 OA Expenditure towards advertisement Decreases Treated as an asset as it increases the brand value
02 OA Expenditure towards new recruits Decreases Treated as an asset as it increases the company’s intellectual capital
03 OA Expenditure towards new equipment Decreases Treated as asset
04 FA Loan means cash inflow to business Increases Loan is a liability
05 FA Deposits via CD means cash inflow Increases CD is a liability
06 FA Issue of fresh capital means cash inflow Increases Treated as a liability as share capital increases
07 IA Investment in startup means cash outflow Decreases Investment is an asset
08 IA Money parked in FD means cash going out of business Decreases Equivalent to cash, hence considered an asset
09 IA Investment in building means cash going out of business Decreases Gross block considered an asset
10 OA Expenditure towards the sound system Decreases Treated as an asset

The table above is colour coded:

  1. Increase in cash is colour coded in blue
  2. Decrease in cash is colour coded in red
  3. Assets are colour coded in green and
  4. Liabilities are colour coded in purple.

If you look through the table and start correlating the ‘Cash Balance’ and ‘Asset/Liability’ you will observe that:

  1. Whenever the liabilities of the company increases the cash balance also increases
    1. This means if the liabilities decreases, the cash balance also decreases
  2. Whenever the asset of the company increases, the cash balance decreases
    1. This means if the assets decreases, the cash balance increases

The above conclusion is the key concept while constructing a cash flow statement. Also, extending this further you will realize that each activity of the company be it operating activity, financing activity, or investing activity either produces cash  (net increase in cash) or reduces (net decrease in cash)the cash for the company.

Hence the total cash flow for the company will be:-

Cash Flow of the company = Net cash flow from operating activities + Net Cash flow from investing activities + Net cash flow from financing activities

8.3 – The Cash Flow Statement

Having some insight into the cash flow statement, you would now appreciate the fact that you need to look into the cash flow statement to review the company from a cash perspective.

Typically when companies present their cash flow statement they split the statement into three segments to explicitly show how much cash the company has generated across the three business activities. Continuing with our example from the earlier chapters, here is the cash flow statement of Amara Raja Batteries Limited (ARBL):

M3-Ch8-Chart1

I will skip going through each line item as most of them are self explanatory, however I want you to notice that ARBL has generated Rs.278.7 Crs from operating activities. Note, a company which has a positive cash flow from operating activities is always a sign of financial well being.

Here is the snapshot of ARBL’s cash flow from investing activities:

M3-Ch8-Chart2

As you can see, ARBL has consumed Rs.344.8 Crs in its investing activities. This is quite intuitive as investing activities tend to consume cash. Also remember healthy investing activities foretells the investor that the company is serious about its business expansion. Of course how much is considered healthy and how much is not, is something we will understand as we proceed through this module.

Finally, here is the snapshot of ARBL’s cash balance from financing activities:

M3-Ch8-Chart3

ARBL consumed Rs.53.1Crs through its financing activities. If you notice the bulk of the money went in paying dividends. Also, if ARBL takes on new debt in future it would lead to an increase in the cash balance (remember increase in liabilities, increases cash balance). We know from the balance sheet that ARBL did not undertake any new debt.

Let us summarize the cash flow from all the activities:

Cash Flow from Rupees Crores (2013-14) Rupees Crores (2012-13)
Operating Activities 278.7 335.4
Investing Activities (344.8) (120.05)
Financing Activities (53.1) (34.96)
Total (119.19) 179.986

This means the company consumed a total cash of Rs.119.19 Crs for the financial year 2013 -2014. Fair enough, but what about the cash from the previous year? As we can see, the company generated Rs.179.986 Crs through all its activities from the previous year. Here is an extract from ARBL’s cash flow statement:

M3-Ch8-Chart4

Look at the section highlighted in green (for the year 2013-14). It says the opening balance for the year is Rs.409.46Crs. How did they get this? Well, this happens to be the closing balance for the previous year (refer to the arrow marks). Add to this the current year’s cash equivalents which is (Rs.119.19) Crs along with a minor forex exchange difference of Rs.2.58 Crs we get the total cash position of the company which is Rs.292.86 Crs. This means, while the company guzzled cash on a yearly basis, they still have adequate cash, thanks to the carry forward from the previous year.

Note, the closing balance of 2013-14 will now be the opening balance for the FY 2014 – 15. You can watch out for this when ARBL provides its cash flow numbers for the year ended 31st March 2015.

At this point, let us run through a few interesting questions and answers:

  1. What does Rs.292.86 Crs actually state?
    1. This literally shows how much cash ARBL has in its various bank accounts
  2. What is cash?
    1. Cash comprises cash on hand and demand deposits. Obviously, this is a liquid asset of the company
  3. What are liquid assets?
    1. Liquid assets are assets that can be easily converted to cash or cash equivalents
  4. Are liquid assets similar to ‘current items’ that we looked at in the Balance sheet?
    1. Yes, you can think of it that way
  5. If cash is current and cash is an asset, shouldn’t it reflect under the current asset on the Balance sheet?
    1. Exactly and here it is. Look at the balance sheet extract below.

M3-Ch8-Chart5

Clearly, we can now infer that the cash flow statement and the balance sheet interact with each other. This is in line with what we had discussed earlier i.e all the three financial statements are interconnected with each other.

8.4 – A brief on the financial statements

Over the last few chapters we have discussed the three important financial statements of the company i.e the P&L statement, the Balance Sheet and the Cash Flow statement of the company. While the Cash flow and P&L statement are prepared on a standalone basis (representing the financial position for the given year), the Balance Sheet is prepared on a flow basis.

The P&L statement discusses how much the company earned as revenues versus how much the company expended in terms of expenses. The retained earnings of the company also called the surplus of the company are carried forward to the balance sheet. The P&L also incorporates the depreciation number. The depreciation mentioned in the P&L statement is carried forward to the balance sheet.

The Balance Sheet details the company’s assets and liabilities. On the liabilities side of the Balance sheet the company represents the shareholders’ funds. The assets should always be equal to the liabilities, only then do we say the balance sheet has balanced. One of the key details on the balance sheet is the cash and cash equivalents of the firm. This number tells us,   how much money the company has in its bank account. This number comes from the cash flow statement.

The cash flow statement provides information to the users of the financial statements about the entity’s ability to generate cash and cash equivalents as well as indicates the cash needs of a company. The statement of cash flows are prepared on a historical basis providing information about the cash and cash equivalents, classifying cash flows in to operating, financing and investing activities. The final number of the cash flow tells us how much money the company has in its bank account.

We have so far looked into how to read the financial statements and what to expect out of each one of them. We have not yet ventured into how to analyze these numbers. One of the ways to analyze the financial numbers is by calculating a few important financial ratios. In fact we will  focus on the financial ratios in the next few chapters.


Key takeaways from this chapter

  1. The Cash flow statement gives us a picture of the true cash position of the company
  2. A legitimate company has three main activities – operating activities, investing activities and the financing activities
  3. Each activity either generates or drains money for the company
  4. The net cash flow for the company is the sum of operating activities, investing activities and the financing activities
  5. Investors should specifically look at the cash flow from operating activities of the company
  6. When the liabilities increase, cash level increases and vice versa
  7. When the assets increase, cash level decreases and vice versa
  8. The net cash flow number for the year is also reflected in the balance sheet
  9. The Statement of Cash flow is a useful addition to the financial statements of a company because it indicates the company’s performance.

81 comments

  1. Amitvikram says:

    What are the two columns in cash flow statement? Why is that all the activities in OA are listed in first column and in FO and IA the activities are on second column also the sign is reverse for OA like input is negative and output is positive why?

    • Karthik Rangappa says:

      Can you please restate your 2nd question with an example “also the sign is reverse for OA like input is negative and output is positive why?”

      And for your first question, this is mainly an accounting practice.The 2nd column represents the ‘Sum Total’ of a main header. Also, I really don’t know why the activities are listed in the 2nd column (for FA and IA). Guess I need to do some research 🙂

      • Amitvikram says:

        In OA, depreciation which is cash out, it is shown as +, “Net income from sale of tangible assets” which is cash in is shown as -. At same time in IA, “purchase of tangible assets” which is cash out is shown as – and “dividends received” is cash in is shown as +. As we can see cash out in OA is + whereas it is – in case of IA and likewise for cash in.

        • deepak says:

          Please answer query of AMITVIKRAM

        • Karthik Rangappa says:

          The sign associated indicates the effect of cash on the cash balance. For example, depreciation is a non cash expense and has to be added back to get the true value of OA, hence it has a +ve sign. Sale of tangible asset is a FA and it tends to increase the cash balance, so has to be +ve. So for every activity, you need to identify the effect it has on cash…if its increasing, its +ve, and if it has a decreasing effect its -ve.

        • CS says:

          See, in OA we are calculating cash generated from operations,while in our pnl Depreciation, provisions, are debited which will not show how much cash by business generated through operating activity, As well Depreciation is a non cash expenses, because we had already bought asset 2-3 yrs ago and we arr reducing it’s cost and charging it to pnl just for matching with revenue,So add back to profit other expenses like various provisions, interest paid on loan, dividend including interim dividend paid, tax refund, transfer from reserve, loss on sale of capital asset have not happen day to day in business and we need to report only recurring activities under OA so they all shall be +/- According to transaction for the ease I am giving you simple proforma of CFS as per AS-3″

          Net profit before taxes :-
          Add-{ if debited in pnl statement}
          Depreciation
          Goodwill
          Amortization of expenses
          Loss on sale of capital asset
          Dividend paid
          Interest on borrowings
          Provisions for diminution in value of asset
          Provision for taxes
          Proposed dividend
          Any other non operating debits
          Less – If credited to PnL
          Profit on sale of asset
          Interest /dividend recieved
          Transfer from reserves
          Net profit before taxes & working capital changes
          Add-Increase in current liability & Decrease in current asset(Except cash)
          Less-Decrease in CL & Increase in CA
          Less – Cash taxes paid in Yr
          Net Cash from operating activity

          B. Cash flow from investing activities
          ADD- Sale of asset /Interest /dividend received
          LESS-Acquire asset

          C. Cash flow from financing activity
          Add-Issue of shares/debenture /Profit on redemption of shares
          Less-Redemption of preference shares /repayment of loan /Interest paid /dividend paid /buy back of shares

          Total A+B+C
          Add-other items not be classified in above categories (insurance premium paid/refund of taxes /contingent payments/receipt etc.
          Opening cash
          Closing cash (B/F)

  2. Nikhil Zelawat says:

    Why we have calculated total cash flow as (IA + FA) – OA
    Here from IA and OA the cash balance is decreasing

    • Karthik Rangappa says:

      IA is usually decreasing because it has an effect of reducing the cash balance. OA can be decreasing based on the numbers. I’ve explained the same in section 8.2, suggest you look at it once again.

  3. T RAMA DEVI says:

    Dear Sir, Thank you for your reponse to my earlier queries/doubts, I am going thro your chapters again and again as it become guide for me for investing and trading. I want to know where can I get reliable figures pertaining to capital expenditure, ROE and ROCE etc.

    • Karthik Rangappa says:

      Future CAPEX inforamtion is usually provided by the company. For historical CAPEX, ROE, and ROCE numbers I usually prefer to check Morning Star India website.

  4. nagendran says:

    Why there isn’t download PDF option available after module 1.

  5. Pearl says:

    Sir, in fifth point you said that cash is a current asset and is reflected in balance sheet. But the number in cash flow statement is 292.8 whereas in balance sheet it is 294.5. Can you explain why it is different in both of them?

    • Karthik Rangappa says:

      Need to check the difference…but 2 Cr difference over 200 Crs can be considered rounding off error 🙂

  6. Michael Mathew says:

    What does it infer if CFO always increasing/decreasing than Net income in consecutive financial reports ???

    • Karthik Rangappa says:

      CFO cannot do this deliberately Micheal….but if the Net Income is increasing then clearly the company is doing good.

  7. Abhilash says:

    Hi sir,I never feel bored while going though your modules. Superb Explanation… I have only one doubt from this chapter.
    FA : Increase the Cash Balance because it come as Liability in Balance Sheet. IA & OA : Decrease the cash balance because it come as a Asset in Balance sheet.
    While calculating Net cash Flow from all activities, A+B+C. How this figure came ?
    I have referred 8.2 section again and again But I didn’t understand yet. Please explain it clearly.

    • Karthik Rangappa says:

      Abhilash, that is because the total cash balance represents the sum of cash positions from all different activities of a firm, hence we need to add it up.

  8. SAILAJA says:

    Hi Karthik, is it okay to have negative oprating cash flow, FCF and high D/E ratio for Banks and Financing institutions as their main Business itself is to Borrow from investors & RBI and lend it Public and Corporates at higher interest rates. I heard during the closure of books at the end of FY, due to some adjustments in borrowing and lending they do show negative operating cash flow but it doesn’t mean such companies are not able to generate healthy cash flow out of the Business.

  9. Ashish Arole says:

    Can we reconcile the change in inventory from Cash Flow Statement to the change in inventory from Income statement or the Balance Sheet (prior year – current year)? I see three different numbers for the same metric on these three statements, how is that possible?

  10. Ravi says:

    Hi Karthik,

    Is Depreciation & Amortization an expense or income

  11. Sainudheen says:

    Dear sir,
    How can i check a particular companies last 5 years Balance sheet & P/L , I mean which website i will get that data ?

  12. Sainudheen says:

    Sir, Thank you so much

  13. Sainudheen says:

    Dear Sir,
    What is the difference between Book value of particular stock and Market price of a particular stock ?

    • Karthik Rangappa says:

      You add up all assets that the company owns and divided it by the number of shares, you get the book value. Market price is the price at which the companys stocks gets traded in the market.

  14. Sainudheen says:

    Sir,
    Stock is trading at 9 times its book value, what is really meant and how it will affect for company share price ?

    • Karthik Rangappa says:

      Book Value is the Net worth divided by Total number of shares. If the stock is trading 9x, it means its overvalued, however you should avoid making such conclusions without studying other details.

  15. Sainudheen says:

    Thanks Sir,

  16. Sainudheen says:

    Sir,
    What you mean by low interest coverage ration for a particular company ,and how it will negativity impact the company ?
    Thank you

    • Karthik Rangappa says:

      Low interest coverage is when the company is earning very little compared to the outstanding interest it has. Ideally a company should be earning more than the interest it has to pay, if not the company will be in a situation where it will have to sell its assets to repay its debt.

  17. Hitesh says:

    You have mentioned that when the liabilities increase, cash level increases and vice versa. My doubt is when liabilities increase, assets also increase by same amount as assets = liabilities, so cash level should also increase when assets increase which contradicts the second statement when the assets increase cash level decreases. What is the flaw in my argument?

    • Karthik Rangappa says:

      We are trying to find out the effect on cash position here. The statement – ” Increase in liabilities tend to increase the cash levels” is with respect to calculating the cash flow from operations. Think about this – how can you increase assets and cash at the same time??

  18. Avinash says:

    I think you are wrong on expenditure towards new equipment. shouldn’t it come on investing activity? as it will be considered a capital expenditure?

  19. Dhinakaran says:

    Karthik,
    Thank you once again for yet another interesting topic. I have a question regarding valuation. I consider ARBL as a good business with ethical management. But it is trading at 30+ PE. 10 Year average PE ranges around 15+. What should I do in this case ? Waiting for the price to come down to 20+ PE is as bad as buying at higher valuation. I think most of the good business is trading at a premium valuation. Could you please let me the approach that I should follow in today’s marking considering valuation in mind?

    • Karthik Rangappa says:

      I was reading somewhere, apparently Bosch has never traded below 20 times earning…and its been a great stock to be invested in. So sometimes, one has to pay up a premium for quality stocks. The trick is to find out how much premium. There is no one % that fits all businesses…one has to evaluate on a case by case basis. You will know this by experience I guess.

  20. Dhinakaran says:

    Karthik,Why do we subtract working capital changes while calculating operating cash flow?
    is it because these are yet to be sold items and wouldn’t have been included in Expenses in PL?

    • Karthik Rangappa says:

      Working capital is the operational cash. A business can either be cash positive or -ve in its operations….and the effect of this to be captured while calculating cash flow from operations.

  21. uday says:

    Good Afternoon Karthink sir,

    can you tell me where exactly i can see those Operational financial charts in moneycontrol?
    kindly let me know the website name and path to get the information for each fund

  22. How does this cash flow fundamentals works in case of banking sector as they invest in others instead of themselves & they lend money to others. Your video on zerodha online about Stock picking techniques – Insights from cash flow statements does not describes as how these fundamentals works for banking sectors.
    Regards,
    Prashant Sharma

    • Karthik Rangappa says:

      Prashant, I’m not too familiar analyzing banking sector, hence I dont think I’m the right person to be answering this.

  23. vignesh supali says:

    Hi Karthik,

    In Cash flow statements of bank or related sector will there be cash generated thru operating activities? or should we give a green flag if it is generating cash from financial activities?

  24. Ayush says:

    Sir,
    what does (119.19) mean, how it differs from 179.986
    Does (119.19) mean the company need more money?

  25. Rahaliyas Aslam says:

    Have been reading through the fundamental analysis module and its excellent……Now would ask you a favour on How you go about analysing a stock … Where do you start from P&L ,Balance Sheet , CF stmt …..which order…. The CF video u shared said about starting and CF stmt then how u move to ratios ,PE DCF etc. I agree that it can be done anyways but as a new bie would like to know how…Hopefully a webinar…. God bless…

    • Karthik Rangappa says:

      As you yourself mentioned, there is no hard and fast rule here. I usually start with P&L as its the easiest…then BS followed by CF.

  26. kiranintouch says:

    Hi Karthik,
    In “Cash Flow From Operating Activities”, request to clarify
    1. How is “f. Donation of tangible fixed asset” inflow of cash. As i understand the term “donation” would mean give away. Hence would it not be outflow.
    2. “g. Interest paid on working capital facilities”. Does it mean that AMRL has saved 0.03 in the payment of interest and hence it is inflow.

    • Karthik Rangappa says:

      1) You can give away cash right? CF only considers whats coming in and going out
      2) Need to double check this. But I’m guessing its not.

  27. Korem says:

    Hi,
    I have often noticed that interest paid is included in both operating and financing activities. What would be the reason for such classification?

  28. Amit gupta says:

    Sir,How to calculate cash from from operating ,investing and financing activities ?

  29. Saurabh says:

    Sir in Allcargo Logistics cash flow statement for the year ending March,2015
    Net cash flows generated from operating activities is 19,613(in Lac) where as in cash flow statement for the year ending March,2016 Net cash flows generated from operating activities is 41623 (in lac for March,2015) same difference is there in each and every year and in most of the companies Kindly explain

  30. sangram panda says:

    sir,
    cash flow statement in your example
    in 2012-13 they added the amount
    but in 2013-14 the deducted it from previous years balance why,
    I am a bit confusing in that part

    • Karthik Rangappa says:

      I’m not sure which example you are talking about here. Can you kindly elaborate? Thanks.

      • sangram panda says:

        sir,
        the example with a red box and a green box where you explain opening and closing balance.
        why they deduct 1191 from 4094 in 2013-2014
        and add 1179 with 2283 in 2012-13.

        • Karthik Rangappa says:

          Opening balance for this year is the same as the closing balance for the previous year. You add this year’s net cash flow to the opening balance and then get the closing balance of the current year…which again becomes the opening balance for the year going forward.

  31. Pawan says:

    Can you or somebody from zeroda make modules on How to do an analysis of banks, because of its different from other industries and very hard to interpret?

  32. Ayush says:

    Sir, in cash flow from operating activities.
    1) Why dep and amortization are added in operating expenses?
    2) why dividend received, int received & prov for warrant are deducted?

    Sir,I am confused in this part.
    Thank you

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