There are not many subjects that make me squirm, however, explaining the statement of cash flows is a subject that conjures up images of snakes crawling over my body in a damp, cold, dark cave. Hopefully in a few short sentences I can sum up what the statement of cash flows represents and how it can be used in making an educated financial decision.
The statement of cash flows is part of the financial statement trio. That trio being the Balance Sheet, Income Statement, and Statement of Cash Flows.
It measures the actual cash inflow and outflow during an accounting period. We all know that cash is king. We live and die by how much cash we can generate through our business. Therefore, cash flow from operations can be a critical measure of overall success.
To create the statement of cash flows each balance sheet account is reordered into three different areas; operating activities, investing activities, and financing activities. Operating activities are those accounts involved in the day to day operations of the company. Investing activities are those accounts that reflect the investment in property, plant and equipment. Financing activities are those accounts reflecting the borrowing and repay of debt.
The statement of cash flows is prepared by calculating the changes in all of the balance sheet accounts, including cash; then listing the changes in all of the accounts except cash as inflows or outflows; and categorizing the flows by operating, financing, or investing activities. The inflows less the outflows balance to and explain the change in cash.
I can already see your eyes glazing over after that last paragraph. Let’s just say that creating the statement of cash flows is beyond what can be explained in this article. Determining if a positive or negative change in an account is an inflow or outflow is not as complicated as you might think, however, to solve that mystery you need to take the Financial Statement Analisys class through NACM.
Let me finish by giving you some useful hints on how to analyze the statement of cash flows to help with your job. Take a look at net cash provided (used) by operating activities. If it is a positive number, the business is able to generate cash internally as opposed to borrowing money to operate. If a business cannot generate a positive cash flow, they generally will not be able to pay their bills timely.
Another quick way to use the statement of cash flows is to compare the same line as above with the net profit on the income statement. This margin measures the ability of the firm to translate sales into cash. This margin should be equal to or greater than the net profit margin. It is cash that pays for the day to day operations of the company, services debt, and pays dividends.
Remember that it is possible for a firm to be highly profitable and not be able to pay their bills, service debt, or pay dividends and go bankrupt. The ongoing operation of any business depends on its success in generating cash from operations.
by Doug Darrington, CCE
REPRINTED FROM JUNE 2019 CreditWise