Question

This week, we covered the income statement and the statement of cash flows. If you could only pick one to review before investing in a company, which one would you select, and why?

Answer 1

Answer

• The cash flow statement and the income statement are integral parts of a corporate balance sheet.
• In order to better understand which statement you should be using, it's important to understand what kind of information each statement provides:
• A cash flow statement shows the exact amount of a company's cash inflows and outflows over a period of time.
• The income statement is the most common financial statement and shows a company's revenues and total expenses, including noncash accounting, such as depreciation over a period of time.

The statement of cash flows is very important to investors because it shows how much actual cash a company has generated. The income statement, on the other hand, often includes noncash revenues or expenses, which the statement of cash flows excludes.

One of the most important traits you should seek in a potential investment is the firm's ability to generate cash. Many companies have shown profits on the income statement but stumbled later because of insufficient cash flows. A good look at the statement of cash flows for those companies may have warned investors that rocky times were ahead

The operations section of cash flow statement converts the Income Statement from accrual to cash and will give you some of the information from the Balance Sheet to have an idea regarding the current (and other liquidity) ratios.

The investments section of cash flow statement lets you know the company's involvement in long-term investments, including property plant and equipment.

The finance section of cash flow statement gives you insight as to how the company uses its issuance of bonds and stocks (preferred or regular).

Free cash flow is a term you will become very familiar with over the course of these workbooks. In simple terms, it represents the amount of excess cash a company generated, which can be used to enrich shareholders or invest in new opportunities for the business without hurting the existing operations; thus, it's considered "free." Although there are many methods of determining free cash flow, the most common method is taking the net cash flows provided by operating activities and subtacting capital expenditures (as found in the "cash flows from investing activities" section).

So, I would first analyse Cash flow statement before making any investment decision.