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Course 108
A Tour through the Cash-Flow Statement


The cash-flow statement is the newest of the three financial statements that companies are required to provide, dating only from 1988. This statement is similar to the income statement in that it records a company's performance over some specified period of time, usually a year or a quarter. But whereas the income statement takes into account some abstract items (such as depreciation), the cash-flow statement strips away all these and tells you how much actual cash the company has generated. Many of the items on this statement are also found on either the income statement or the balance sheet, but here they're arranged to highlight the cash generated and how it relates to reported earnings. The cash-flow statement is divided into three parts: cash flows from operating activities, from investing activities, and from financing activities.

Cash Flows from Operating Activities

The "Cash Flows from Operation Activities" section tells you how much cash the company generated from its business, as opposed to more peripheral things such as investments.

Net Income. This figure is simply taken from the income statement. All the items below are added to or subtracted from net income to get net cash provided by operating activities.

Depreciation and Amortization. When a company buys an asset intended to last a long time, it amortizes (spreads out) the cost of that asset on its income statement. (See Stocks 106 for a more detailed discussion of the income statement.) This number is sometimes included on the income statement, and it is always included in the cash-flow statement. Since it's a noncash charge, it's added back to net income as one step in figuring operating cash flow.

Deferred Taxes. Deferred taxes arise because companies are allowed to calculate depreciation differently when figuring their taxes than they do when reporting their financial results to the Securities and Exchange Commission. The details can get rather complicated, but the important thing for our purposes is that deferred taxes is another noncash charge that is added back to net income in figuring cash flow.

Changes in Assets and Liabilities (Receivables, Inventories, Payables). When inventories or accounts receivable go up, the company's cash flow decreases, because these things represent money that's tied up in the business and not available for spending. Conversely, when inventories or receivables go down, cash flow increases.

Foreign-Currency Adjustments. U.S. companies that do a significant amount of business overseas will generally be paid in a variety of foreign currencies, all of which have to be translated into U.S. dollars. The foreign-currency adjustment is necessary to account for changes in exchange rates between the time the payment is made and the time of the financial statement.

One-Time Charges. Sometimes a company will take a one-time cash charge, such as a write-off related to an acquisition. Any such charges have to be added back into net income when figuring cash flow.

Net Cash Provided by Operating Activities. Also known as operating cash flow, this is the result of adding or subtracting the above items from net income. It doesn't replace net income, but can be used as a supplement to it. It is important to look at operating cash flow when examining companies with a lot of amortization and special charges each year, which make it hard to compare the company's performance from year to year.

Cash Flows from Investing Activities

The second major portion of the Statement of Cash Flows is the "Cash Flow from Investing Activities" section. These are activities that involve acquiring or disposing of noncurrent assets. Below are some of the major line items that show up in this section:

Capital Expenditures. This figure represents money spent on items that last a long time such as property, plant, and equipment--basically, anything needed to keep the business running and growing at its current rate. Operating cash flow (see above) minus capital expenditures equals free cash flow, or the amount of cash the company generates after investing in its business. When capital spending increases, it often means the company is expanding by building new stores or factories.

Investment Proceeds. Companies will often take some of their excess cash and invest it in an effort to get a better return than they could in a plain old money-market fund. This figure tells how much money the company has made (or lost) on such investments.

Purchases or Spin-offs of Businesses. This figure includes any money the company made from buying or selling (spinning off) subsidiary businesses. Sometimes this figure will be in the cash flows from operating activities section, rather than here.

Cash Flows from Financing Activities

The final portion of the Statement of Cash Flows is the "Cash Flow from Financing Activities" section. These include any activities involved in transactions with the company's owners or creditors. Some things that typically show up in this section:

Dividends Paid. This figure is the total dollar amount the company paid out in dividends over the specified time period. (For dividends per share, you have to look elsewhere.) Young, growing companies and many mature technology companies tend not to pay dividends.

Issuance/Purchase of Common Stock. This is an important number to look at because it indicates how a company is financing its activities. New, rapidly growing companies will often issue lots of new stock; this practice dilutes the value of existing shares, but it also gives the company cash for expansion. Slower-growing companies that generate a lot of free cash flow tend to be the ones that buy back their own stock. This increases the value of existing shares and shrinks the company's asset base; it's sometimes used as a way of returning value to shareholders.

Issuance/Repayments of Debt. This number tells you whether the company has borrowed money or repaid money it previously borrowed. Borrowing is the main alternative to issuing stock as a way for companies to raise capital. It tends to be used more by older, more mature companies, because they can generally borrow money at a much lower rate than an unproven startup.


Quiz 108
There is only one correct answer to each question.

1 What is a major difference between the income statement and the cash-flow statement?
a. The cash-flow statement strips away all abstract, noncash charges.
b. The cash-flow statement refers to a single point in time, rather than a period of time such as a year.
c. The cash-flow statement is optional.
2 Which of the following will decrease a company's operating cash flow?
a. A decrease in inventories.
b. A decrease in accounts receivable.
c. An increase in accounts receivable.
3 Which of the following is <em>not</em> true about operating cash flow?
a. It is always greater than net income.
b. It is often a useful measure for companies with a lot of amortization and one-time charges.
c. It doesn't include cash flow from issuing stock or debt.
4 All else being equal, when a company's capital spending increases:
a. It increases free cash flow.
b. It generally means that the company is expanding.
c. It means the company will have to issue either stock or debt to pay for the spending.
5 Young, growing companies:
a. Generally pay high dividends.
b. Tend to borrow money rather than issue stock.
c. Tend to issue stock in order to get money to expand.
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