Lesson 3: The Cash Flow Statement

Cash Flow, balance sheet, income statement, fundamental analysis

Cash Flow, balance sheet, income statement, fundamental analysisA new article about Fundamental Analysis. After the balance sheet and the income statement, now we see the cash flow. The cash flow statement shows how much cash comes in and goes out from the company during the quarter or year. It differs from the income statement for some aspects.

Companies have to record revenues and expenses when transactions occur, but not when cash is exchanged. The income statement often includes non-cash revenues or expenses, which the statement of cash flows does not include.

If the income statement of a company shows a net income of $ 1,000 does not means that the company has $ 1,000 in cash. I show you that with a simple example.

I sell products for $ 10,000, and I have expenses for $ 8,000. In this case, I have a net income of $ 2,000. If all that I sold, I got it, and if all that I bought I paid it, at the end of the financial period I have a cash flow for $ 2,000, and in this case the generated cash flow also corresponds to the net income.

However, I grant extended payments to the customers for paying the bills, and I decide to pay all my expenses immediately. So, at the end of the financial period, I got $ 6,500 by customers and expenses for $ 8,000. In this case, even though I always have a net income of $ 2,000, I have a cash flow drop of $ 1,500.

Because it shows how much actual cash a company has generated, the statement of cash flows is significant to understand a company's fundamentals. It shows how the company can pay for its operations and future growth. Just because a company shows a profit on the income statement does not mean it cannot get into trouble later because of insufficient cash flows.

The cash flow statement is divided into three sections:

  • From Operating Activities. It usually refers to the net cash inflow reported in the first section of the statement of cash flows, and it shows how much cash comes from sales of the company's goods and services, less the amount of cash needed to make and sell those goods and services.
  • From Investing Activities. It relates to the amount of money the company has spent on investments, as new equipment, or whatever else is needed to keep the business going. It also includes acquisitions of other companies.
  • From Financing Activities. Cash flows from financing activities is the last of the three sections of a cash flow statement. It shows the cash inflows and outflows related to transactions with the providers of finance, i.e. the banks or creditors. Typical sources of cash inflow would be cash raised by selling stock and bonds or by bank borrowings.

 Below, you can see a sample Cash Flow Statement (click to enlarge).

Cash Flow, fundamental analysis

In the next article, we will start to see the Financial Ratios and the Financial Ratio Analysis.


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