Question

"Statement of Cash Flows" A Statement of Cash Flows is often one of the least used and understood of the key Financial Statements. However, it is a critical report to use when evaluating or analyzing a company. Showing where a company is receiving and using its cash - through Operations, Investing, and Financing - this report can be used to help evaluate liquidity, solvency, and financial flexibility. Analyze the key sections of the Statement of Cash Flows: Cash from Operations, Cash from Investing, and Cash from Financing. Provide your opinion on the most important section for evaluation. Discuss the implications of a negative cash flow from any of the key sections.

Answer 1

The purpose of the cash flow statement is to show where an entities cash is being generated (cash inflows), and where its cash is being spent (cash outflows), over a specific period of time (usually quarterly and annually). It is important for analyzing the liquidity and long term solvency of a company.

The cash flow statement uses cash basis accounting instead of accrual basis accounting which is used for the balance sheet and income statement by most companies. This is important because a company may accrue accounting revenues but may not actually receive the cash. This could produce profits and taxes payable but not provide the resources to stay solvent.

Cash Flow from Operating Activities

The net amount of cash coming in or leaving from the day to day business operations of an entity is called Cash Flow From Operations. Basically it is the operating income plus non-cash items such as depreciation added. Since accounting profits are reduced by non-cash items (i.e. depreciation and amortization) they must be added back to accounting profits to calculate cash flow.

Cash flow from operations is an important measurement because it tells the analyst about the viability of an entities current business plan and operations. In the long run, cash flow from operations must be cash inflows in order for an entity to be solvent and provide for the normal outflows from investing and finance activities.

Cash Flow From Investing Activities

Cash flow from investing activities would include the outflow of cash for long term assets such as land, buildings, equipment, etc., and the inflows from the sale of assets, businesses, securities, etc. Most cash flow investing activities are cash out flows because most entities make long term investments for operations and future growth.

Cash Flow From Finance Activities

Cash flow from finance activities is the cash out flow to the entities investors (i.e. interest to bondholders) and shareholders (i.e. dividends and stock buybacks) and cash inflows from sales of bonds or issuance of stock equity. Most cash flow finance activities are cash outflows since most entities only issue bonds and stocks occasionally.

Summary of Cash Flow Activities:

+/- Cash Flow From Operating Activities

+/- Cash Flow From Investing Activities

+/- Cash Flow From Financing Activities

= Net Change in Cash

+ Beginning Cash Balance

= Ending Cash Balance

The most important section is the Cash Flow from Operating Activities. IIt tells how much cash a firm generates from its operating activities because it paints the best picture of how well the business is producing cash that will ultimately benefit shareholders.

Simply put, it means more money is pumped out of the business than is being generated which is likely to have negative impact on a business. A negative cash flow may most likely involve increasing borrowing with associated costs, Investment in Assets, Raising funds, and so on