Tuesday, April 27, 2010

The Cash Flow Statement

A cash flow statement gives you a peek into a company's checking account. Like a bank statement, it tells how much cash was on hand at the beginning of the period, and how much was on hand at the end of the period. It then describes how the company spent its cash. As with a checkbook, uses of cash are recorded as negative figures, and sources of cash are recorded as positive figures.

If you're a manager in a large corporation, changes in the company's cash flow won't typically have an impact on your day-to-day functioning. Nevertheless, it's a good idea to stay up to date with your company's cash flow projections, because they may come into play when you prepare your budget for the upcoming year. For example, if cash is tight, you will probably be asked to be conservative in your spending. Alternatively, if the company is flush with cash, you may have opportunities to make new investments.

If you're a manager in a small company, you're probably keenly aware of the firm's cash flow situation, and feel its impact almost every day. The cash flow statement is useful because it shows whether your company is turning profits into cash—and that ability is ultimately what will keep your company solvent.

The cash flow statement doesn't measure the same thing as the income statement. If there is no cash transaction, it cannot be reflected on a cash flow statement. Notice, however, that net income on the cash flow statement is the same as the bottom line of the income statement—it's the company's profit. Through a series of adjustments, the cash flow statement translates this net income to a cash basis.

In general, a company looks to three sources of cash: ongoing operations, investment activities, and financing activities. It's traditional to start with ongoing operations.

Accounts receivable and inventory represent items the company has produced, but hasn't received payment for. Prepaid expenses represent items the company has paid for but has not consumed. These items are all subtracted from cash flow.

Accounts payable and accrued expenses represents items the company has already received or used, but hasn't yet paid for. So these items add to cash flow.

Investment activities can be

  • cash the company uses to invest in financial instruments or plant, property, or equipment (such investments in PP & E are often shown as capital expenditures)
  • gains realized from the sale of plant, property, or equipment
  • gains realized from converting its investments into cash.

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