The Cash Flow Statement: Tracing the Sources and Uses of Cash
by Joe Lan, CFA
Earnings, dividends and growth rates are useful figures in investment analysis. However, like water to humans, there is an underlying element essential to the survival and success of any firm—cash flow.
In this installment of the financial statement analysis series, I discuss the corporate cash flow statement, providing an in-depth look at its sections and explaining what the line items mean.
In this article
- The Linking Statement
- Cash Flow From Operating Activities
- Cash From Investing Activities
- Cash From Financing Activities
- Currency Translation
- Net Change in Cash
- Analysis of Cash Flows
- Free Cash Flow
- Other Articles in the Financial Statement Analysis Series
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The Linking Statement
Under accrual accounting (the methodology followed by publicly traded corporations), earnings and cash flow are two very different figures. The earnings figure, the income statement’s “bottom line,” is based on the principles of accrual accounting. Accrual accounting attempts to match expenses with revenues regardless of when the cash transactions that deal with the creation of the goods being sold and the receipt from the sale occurred. In essence, accrual accounting is not entirely concerned with when “cash trades hands.” This method of accounting introduces many interpretations and estimates from management that can vary from firm to firm.
For example, higher sales may not translate into higher cash flow if accounts receivable are allowed to rise. (Customers may not pay when goods are delivered, but rather may be invoiced.) Furthermore, cash may be used to build up inventories, which may depreciate in value or even become obsolete if products are not sold in a timely manner. The expenses to build up these inventories are not recorded until products are actually sold. Even inventory recognition may vary from firm to firm if one company uses first-in-first-outaccounting and another uses last-in-first-out accounting.
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