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
- Conclusion
- 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-out (FIFO) accounting and another uses last-in-first-out (LIFO) accounting.
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Discussion
I have read and copied all four articles so far. They are excellent. Mine are in a binder for continual referral and as loan-out to members in my small financial investment group. Thank Joe for a great job. Material like this makes membership in AAII a must!
Richard G. Post
Vero Beach Florida
posted 8 months ago by Richard Post from Florida
This article makes me think AAII membership worthwhile! I will read more of the other ones.
Thanks Joe for doing such a good job.
posted 8 months ago by Evelyn S Postoluck from California
I am confused. If "net change in cash is the aggregate of cash flows from operating, investing and financing activities.". Why doesn't 184.75 -120. -34.75 = 30. Table 1 states it as 20. Am I missing something?
posted 8 months ago by B Kirschner from Pennsylvania
No, you are right B Kirschner. The income from investing activities from should -130.00 as (-40) + (-40) + (-50) is -130. We must have missed this in our checks. Thank you for bringing it to my attention.
posted 8 months ago by Joe Lan from Illinois
Great article. I've been trying to figure out cash flow for years. Key understanding for me was the "accrual" nature of the income statement versus the cash flow. Now if I can only apply this to actual, real-life cases.
This one article makes my membership fee worthwhile & inspires me to find the previous articles in the series.
posted 7 months ago by R Ebeling from Arizona
I spotted the same discrepancy that B Kirschner did when reading through the print copy of this article, so thanks for the correction. However, it leads me to another quandary.
Based on the balance sheet from the May issue, I don't see why "Capital expenditures" is -$40 and "Other cash flows from investing activities" is -$50. It seems to me that perhaps the labels should be switched on these two items, because on the balance sheet, "Other long term assets" increased $40 (from $80 to $120), and "Plant, property and equipment" increased $50 (from $400 to $450).
Of course, if the increase in PP&E is figured net of accumulated depreciation, then the increase is indeed $40 (from $360 to $400). But figuring it that way doesn't seem like the right thing to do, as the whole point of the cash flow statement is to look at real cash inflows and outflows, and not accrued amounts.
Does this make sense?
posted 5 months ago by Michael Curry from California
I was trying to find your stats on Value Line for APPL. I was OK on net income & sales, but assets & equity were different. I do not get S I Pro. Any suggestions?
posted 2 months ago by Leland Baker from Virginia
See this is what gets me about stock analysis. Under the Cash from Investing Activities explanation, the advice when evaluating this for a particular company is: "...However, be sure to ascertain whether the company is making wise investments and has good growth prospects..."
I mean, how is a guy sitting at my dining room table in NJ supposed to really be able to realistically evaluate something like this in order to help make good investment decisions for a company doing business in Texas. Or forget about Texas, how about the company in the next town over. Unless you are intimately involved in the business or know someone on the inside this seems to me akin to saying "Before you bet on the horse, make sure he's been eating well, is not sick, and the jockey isn't trying to throw the race". How can one even begin to hazard a calculated, educated guess on something so intangible?
posted 7 days ago by NewJoizey from New Jersey
