The Cash Flow Statement

The cash flow statement doesn't measure the same things as the income 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 a the beginning of the period, and how much was on hand at the end of the period. I then describes how the company spent its cash.

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. But you can affect cash flow in your company. And 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. Alternative, 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 firms 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. You can see in the example below that cash flow of $95,500 was generated.

STATEMENT OF CASH FLOWS, 2004

Net Income $347,000
Depreciation $42,500
Accounts receivable $(43,000)
Inventory $(80,000)
Prepaid expenses $(25,000)
Accounts payable $20,000
Accrued expenses $21,000
Income tax payable $8,000

Cash Flow from Operations $291,000
Property, Plant, Equipment $(7,500)

Cash Flow from Investing Activities $(7,500)

Short-term Debt $(91,000)
Long-term borrowings $90,000
Contributed capital $0
Cash dividends to stockholders $(188,000)

Cash Flow from Financing activities $(188,000)

Increase in cash during year $95,500

The cash flow statement doesn't measure the same things as the income statement. If there is not cash transactions, it cannot be reflected on a cash flow statement. Notice, however, that the cash flow statement starts with net income. Then, through a series of adjustments based on the increases and decreases in asset and liability accounts from the balance sheet, the cash flow statement translates this net income into cash.

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 - the amount that customers owe for products and services.
Accounts Payable - the amount the company owes its vendors for supplies but not yet paid for.

Investment activities can be:

• Cash the company uses to invest in financial instruments or property, plant and equipment.
• Proceeds from the sale of plant, property and equipment
• Proceeds from converting its investments into cash.

Financing activities include raising money by borrowing in the capital markets and issuing stock. Dividends must be paid out of cash flow; they represent a decrease in cash flow.

ACTION POINT: Understand the activities that affect the companies cash position.