Cash Flow Analysis and Statement

AuthorMichael Luehlfing, Laurie Hillstrom

Page 70

Cash flow analysis is a method of analyzing the financing, investing, and operating activities of a company. The primary goal of cash flow analysis is to identify, in a timely manner, cash flow problems as well as cash flow opportunities. The primary document used in cash flow analysis is the cash flow statement. Since 1988, the Securities and Exchange Commission (SEC) has required every company that files reports to include a cash flow statement with its quarterly and annual reports. The cash flow statement is useful to managers, lenders, and investors because it translates the earnings reported on the income statement—which are subject to reporting regulations and accounting decisions—into a simple summary of how much cash the company has generated during the period in question. "Cash flow measures real money flowing into, or out of, a company's bank account," Harry Domash notes on his Web site, "Unlike reported earnings, there is little a company can do to overstate its bank balance."


A typical cash flow statement is divided into three parts: cash from operations (from daily business activities like collecting payments from customers or making payments to suppliers and employees); cash from investment activities (the purchase or sale of assets); and cash from financing activities (the issuing of stock or borrowing of funds). The final total shows the net increase or decrease in cash for the period.

Cash flow statements facilitate decision making by providing a basis for judgments concerning the profitability, financial condition, and financial management of a company. While historical cash flow statements facilitate the systematic evaluation of past cash flows, projected (or pro forma) cash flow statements provide insights regarding future cash flows. Projected cash flow statements are typically developed using historical cash flow data modified for anticipated changes in price, volume, interest rates, and so on.

To enhance evaluation, a properly-prepared cash flow statement distinguishes between recurring and nonrecurring cash flows. For example, collection of cash from customers is a recurring activity in the normal course of operations, whereas collections of cash proceeds from secured bank loans (or issuances of stock, or transfers of personal assets to the company) is typically not considered a recurring activity. Similarly, cash payments to vendors is a recurring activity, whereas repayments of secured bank loans (or the purchase of certain investments or capital assets) is typically not considered a recurring activity in the normal course of operations.

In contrast to nonrecurring cash inflows or outflows, most recurring cash inflows or outflows occur (often frequently) within each cash cycle (i.e., within the average time horizon of the cash cycle). The cash cycle (also known as the operating cycle or the earnings cycle) is the series of transactions or economic events in a given company whereby:

Cash is converted into goods and services.

Goods and services are sold to customers.

Cash is collected from customers.

To a large degree, the volatility of the individual cash inflows and outflows within the cash cycle will dictate the working-capital requirements of a company. Working capital generally refers to the average level of unrestricted cash required by a company to ensure that all stakeholders are paid on a timely basis. In most cases, working capital can be monitored through the use of a cash budget.


In contrast to cash flow statements, cash budgets provide much more timely information regarding cash inflows and...

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