Now that we have completed our guides to understanding your company’s balance sheet (Part I and Part II) and income statement (Part I and Part II), it is time to turn our attention to the third and final of the major financial statements, the statement of cash flows. Like the income statement, the statement of cash flows gives us a picture of a company’s performance for a period of time, usually a calendar year or quarter. But while the income statement is concerned with tracking net income, the statement of cash flows, as the name implies, is concerned with reporting changes in a firm’s cash position. As we take a look at our sample statement of cash flows and decipher its entries, we will see that a company’s net income is very different from its cash position.
ABC Corp. Statement of Cash Flows for 2010
|Cash Provided or Used|
|Adjustments Due to Changes in Working Capital:|
|Increase in Accounts Receivable||($12,500)|
|Increase in Inventories||($15,000)|
|Increase in Accounts Payable||$1,500|
|Increase in Accrued Payroll||$1,000|
|Net Cash Provided by Operating Activities||($2,000)|
|Cash Used to Acquire Fixed Assets||($8,500)|
|Sale of Short-Term Investments||$2,000|
|Net Cash Provided by Investing Activities||($6,500)|
|Increase in notes payable||$3,500|
|Net Cash Provided by Financing Activities||$3,500|
|Net Change in Cash||($5,000)|
|Cash at Beginning of Year||$12,000|
|Cash at End of Year||$7,000|
As we can note from the above sample of our fictitious ABC Corporation, the statement of cash flows is broken down into three categories—operating activities, investing activities, and financing activities—plus a summary section at the bottom. If you are now familiar with the balance sheet and income statement from our previous posts, you should recognize most of the line items here because what the statement of cash flows does is pull information from those two statements in order to analyze their effects on ABC’s cash position. As we go through the entries below, you may want to refer back to ABC’s balance sheet and income statement to see where the numbers are coming from.
Net Income – Is the “bottom line” figure from the income statement.
Increases in Accounts Receivable, Inventories, Accounts Payable, and Accrued Payroll – These are all calculated by taking the difference between these figures on two successive balance sheets (e.g. 2010 and 2009 year-end). For simplicity’s sake we only provided one year’s balance sheet for ABC Corp., but once your business has produced two or more balance sheets you would simply use the two most recent ones in order to make these calculations. One important thing to note here is that an increase in a current asset decreases cash while an increase in a current liability increases cash. For example, if your inventory (a current asset) increased, your cash would have to decrease by a like amount to pay for that inventory.
Cash Used to Acquire Fixed Assets – Calculated by taking the difference between the “Fixed Assets” entries on the two most recent balance sheets.
Sale of Short-Term Investments – Reflects short-term investments that have been converted to cash.
Increase in Notes Payable – Indicates the amount of additional short-term debt ABC has taken on.
Net Change in Cash – Equals the sum of the net cash provided by operating, investing, and financing activities.
Cash at Beginning of Year – Equals the Cash figure at the top of the most recent balance sheet.
Cash at End of Year – Cash at beginning of year minus the net change in cash.
Next, we will teach you how to analyze the statement of cash flows and show you why one item on it just might be the single most important figure to look at when analyzing any company.