Question

Why does a company report a different number for cash flows and income that a firm has generated, shouldn't they yield the same number?
Also what does each section of the cash flow statement tell you about the firm?

Answer 1

If a company reports earnings for $1 million, it does not mean that the company has that much cash in the bank. The financial statements are prepared on the accrual basis of accounting, which takes into account non-cash items, such as depreciation, asset impairment, profit on the sale of fixed assets,etc.
Accrual basis of accounting is a method of accounting wherein revenues are recognized when earned rather than when cash is received and expenses are recognized when incurred rather when paid. Example Unearned Revenues, Prepaid Expenses, etc.

Cash Flows refers to the operational turnover of the business and its ability to generate revenues. It clarifies the state of a company's cash flow at a point of time.
Just because the company is generating cash does not necessarily mean the company is profitable.
For example, if a manufacturing company is experiencing low demand and, therefore, decides to sell off part of its factory equipment at liquidation prices. The company will receive cash from the buyer for the used equipment, but it is losing money on the sale; the company would prefer to use the equipment to manufacture products and earn an operating profit. This will result in positive cash flows, but its current and future profit-earning potential would be bleak. Also, cash flow will be positive but profitability is negative.

Therefore, A company reports a different number of cash flows and income that a firm has generated.

The purpose of the Cash Flow Statement is to see the company's sources and uses of cash over a specified period of time. Cash Flow Statement as three parts:

• Cash Flow from Operating Activities- It measures the cash flow generated or used by the company's operational activities. It provides feedback on the company's ability to generate income from internal sources.
• Cash Flow from Investing Activities- It measures the cash provided or used by the purchase and sale of capital assets and long-term investments. It assesses company's ability to meet future expansion requirements.
• Cash Flow from Financing Activities- It measures the cash flow between a firm and its owners and creditors. Negative flow means the company is servicing debt, but it can also mean that company is providing dividend payments or making stock repurchases which will satisfy investors. It provides information for net flows of cash that are used to fund the company.