Course 303: The Statement of Cash Flows
Cash Flows from Operating Activities
In this course
1 Introduction
2 What It Tells You
3 Cash Flows from Operating Activities
4 Cash Flows from Investing Activities
5 Cash Flows from Financing Activities
6 The Bottom Line

Because companies can generate cash in several different ways, the statement of cash flows is separated into three sections: cash flows from operating activities, from investing activities, and from financing activities.

The cash flows from operating activities section comes first and tells you how much cash the company generated from its core business, as opposed to peripheral activities such as investing or borrowing. This is the area you should focus most of your attention on because it paints the best picture of how well a firm's business operations are producing cash that will ultimately benefit shareholders.Some of the main line items found in this section are described below:

Net Income. This figure is taken directly from a company's income statement. Net income is the starting point of how much cash a company provides from its operations. However, there are plenty of items on the income statement that affect income but don't affect cash flow, so all the remaining items are adjustments to net income that help you reconstruct how much actual cash was generated by the business.

Depreciation and Amortization. As we mentioned in Lesson 301, depreciation is accounting's way to record wear and tear on a company's property, plant, and equipment (PP&E). Even though it's an expense on the income statement, depreciation is not a cash charge, so it's added back to net income.

Changes in Working Capital. Working capital is calculated as current assets minus current liabilities on the balance sheet (see Lesson 302). Just as the name suggests, working capital is the money that the business needs to "work." Therefore, any cash used in or provided by working capital is included in the "cash flows from operating activities" section.

Any change in the balances of each line item of working capital from one period to another will affect a firm's cash flows. For example, if a company's accounts receivable increase at the end of the year, this means that the firm collected less money from its customers than it recorded in sales during the same year on its income statement. This is a negative event for cash flow and may contribute to the "Net changes in current assets and current liabilities" on the firm's cash flow statement to be negative. On the flip side, if accounts payable were also to increase, it means a firm is able to pay its suppliers more slowly, which is a positive for cash flow.

We're all about shortcuts to make financial statement analysis easier, so here's a little secret that's all you really need to remember regarding changes in working capital:

  • If balance of an asset increases, cash flow from operations will decrease.
  • If balance of an asset decreases, cash flow from operations will increase.
  • If balance of aliability increases, cash flow from operations will increase.
  • If balance of aliability decreases, cash flow from operations will decrease.

Current assets may include things like inventories and accounts receivable, while current liabilities would include short-term debt and accounts payable.

Net Cash Provided by Operating Activities. After all adjustments to net income are accounted for, what's left over is the net cash provided by operating activities, also known as operating cash flow. This number is not a replacement for net income, but it does provide a great summary of how much cash a company's core business has generated.

Next: Cash Flows from Investing Activities >>


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