Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

10 Things to Know About Every Cash Flow Statement

Compared with the income statement or the balance sheet, the cash flow statement gets perhaps the least amount of attention from everyday investors. Ironically, the cash flow statement can be the most telling of the three financial statements; in fact, it's the only financial statement that matters to many investors. Here are ten things you need to remember about this important report.
 

1. The cash flow statement explains the changes in a company's cash balance.

The cash flow statement is broken into three sections covering the fundamental components of every business: cash from operations, cash from investing activities, and cash from financing activities. In general, the cash from operations section deals with the cash inflows and outflows directly related to the company's primary activity: selling a good or service. The cash from investing activities section shows  how much the company spent (or made) on buying (or selling) assets such as property, equipment, or even other companies. The cash from financing activities shows the inflows and outflows of capital the company uses to fund its operations; this is where one sees the proceeds from equity offerings, for example, or payments on bonds or bank debt.

2. The cash flow statement answers the question: Is this company generating cash or using cash?

Not only does it answer this question, it shows the reader what aspects of the business are generating the cash and what aspects are burning the cash. In many analytical situations, there is nothing as important as knowing its sources and uses of cash.  For example, the income statement may show an increase in sales, but if a company is burning through the cash instead of retaining it, this could potentially be a sign of trouble.

3. Cash flow is not the same as profit or net income!

Income statements and balance sheets include non-cash expenses, depreciation often being the largest of those. But guess what?  Nobody's actually writing a check to "Depreciation." It's a non-cash expense, so the cash flow statement gets rid of it. This is a big reason companies might never show a dime of net income but could be spinning off millions in cash.

4. The cash flow statement doesn't care whether this month's cash outflows are for transactions actually associated with next month or next year.

This is somewhat of a rehash of point #3, but it's important. One of the beautiful things about the cash flow statement is that, for the most part, it simply tracks the movement of cash. It is not as influenced by accrual accounting methods, which record expenses in the period in which they're incurred. For example, if the accounting department cuts a check to Allstate for, say, the next six months of insurance premiums, this month's income statement will only reflect one-sixth of the check amount each month for the next six months. This month's cash flow statement, however, will show the full amount of the check as a cash outflow, because that's what actually happened to the cash. The cash flow statement doesn't care that the bill was for the next six months of insurance. It only cares that cash left the account.

5. The cash flow statement discloses the total amount of cash used to purchase assets or make other capital expenditures.

As mentioned, the cash from investing activities section discloses the amount of cash involved in purchasing or divesting capital assets during a certain period. This is helpful for determining how far along a particular project may be, how much a particular acquisition "really" cost when intangible costs are considered, or how much the company got for the sale of certain assets.

6. The cash flow statement shows the company's debt payments--both interest and principal.

Like your mortgage, corporate payments on debt are usually made up of interest and principal. However, the income statement typically only shows the interest portion, and the balance sheet typically only shows the principal. It's much easier to look at the cash flow statement if you want to know the actual size of the whole payments.

7. Companies raise capital all the time, but if you really want to see what was actually wired into the company's cash accounts, check the cash flow statement.

A company might tell everyone that it is doing a $10 million equity offering, but if that offering is spread over several months or years, or it involves fees and expenses, the cash flow statement is the only primary financial statement that will tell you exactly how much actually went into the company's cash account and when.

#-ad_banner_2-#8.  Changes in the income statement and balance sheet affect the cash flow statement.

It's important to remember that the financial statements are integrated. If the income statement changes, the cash flow statement almost always changes. After any change in revenue or expenses affects net income, and net income is the first line on the cash flow statement. If the balance sheet changes, the cash flow statement almost always changes.

9. Changes in working capital are considered sources and/or uses of cash.

This is one area that often trips up people who are new to the cash flow statement. Accounts payable and accounts receivable are big components of working capital--the source of a company's short-term liquidity. So when accounts receivable--those are monies owed from vendors and whatnot--goes up, for example, it means that customers are paying their accounts. The company is receiving those cash pay ments. Likewise, the opposite is true: increases in accounts receivable are considered uses of cash.

10. The ending cash flow for a particular period should equal the cash shown on the balance sheet for that period. 

If the two statements do not tie in this way, it is likely an error occurred.