Cash Flow Statement to the Rescue!
The cash flow statement (CFS) reconciles net income to a company’s actual change in cash balance over a period in time (quarter or year). It is a line-by-line reconciliation, starting with net income and ending with total change in cash balance.
Along with the income statement and the balance sheet, the cash flow statement is required by the Securities and Exchange Commission (SEC).
Unlike the income statement, whose primary purpose is to present a company’s operating performance, the major purpose of the cash flow statement is to present the movement of cash.
The cash flow statement has become increasingly important for the purposes of financial analysis because the income statement and balance sheet can be manipulated through the use of different accounting methods and assumptions, while a company’s uses and sources of cash are objectively recorded when cash is paid and received, respectively.
Cash inflows/outflows are segregated into three major categories in the CFS (Exhibit 7.1):
Cash Flow from Operating Activities
Tracks cash generated in the course of a company’s day-to-day operations.
These cash flows typically track the cash impact of changes in current assets and current liabilities.
Cash Flow from Investing Activities
Tracks additions and reductions to fixed assets and monetary investments during the year.
These cash flows typically track the impact of changes in long-term assets.
Cash Flow from Financing Activities
Tracks changes in the company’s sources of debt and equity financing.
These cash flows typically track the impact of changes in debt and shareholders′ equity.
Exhibit 7.1. Cash Inflows/Outflows are Segregated into Three Major Categories: Cash From Operating, From Investing, and From Financing Activities
Source: Used with permission of Wal-Mart Inc.
| Major Typical Components and Their Definitions | |
|---|---|
| Net Income | Starting point of cash flow statement |
| Plus: Depreciation & amortization | Add back noncash D&A expense |
| Plus: Increase in accounts payable | Add back reported expenses not actually paid in cash |
| Plus: Increase in other current operating liabilities (nondebt) | Add back reported expenses not actually paid in cash (deferred liabilities, etc.) |
| Less: Increase in accounts receivable | Deduct reported revenues not received in cash |
| Less: Increase in inventories | Deduct amounts paid in cash to buy inventories, but not counted as cost of goods sold (COGS) |
| Less: Increase in all other current assets (except cash) | Varies |
| Less: Gain on sale of assets | Deduct gain reported in net income that are part of cash flow from investing activities |
| CASH FLOW FROM OPERATING | Usually a positive number |
| Plus: Proceeds from sale of long-term assets and investments | Cash inflow that includes gain (loss) on the sale of asset or investment |
| Less: Capital expenditures | Outlays for property, plant and equipment (PP&E) and other investments |
| Less: Increase in all other long-term assets | Outlays for PP&E and other investments |
| CASH FLOW FROM INVESTING | Usually a negative number |
| Plus: Increase in bank loans | Net capital raised from negotiated debt |
| Plus: Increase in long-term debt | Net capital raised from negotiated debt |
| Plus: Increase in preferred stock | Net capital raised from issuing new preferred and common shares |
| Plus: Increase in common stock | Net capital raised from issuing new preferred and common shares |
| Plus: Increase in paid-in-capital | Net capital raised from issuing new preferred and common shares |
| Less: Increase in treasury stock | Payments for repurchasing common stock |
| Less: Dividends paid | Payments to preferred and common shareholders |
| CASH FLOW FROM FINANCING | Can be either positive or negative |
| INCREASE IN CASH AND CASH EQUIVALENTS | Must agree with the net change in cash and cash equivalents on the balance sheet |