The Cash Flow Statement

The cash flow statement, also called the consolidated statement of cash flow or statement of consolidated cash flow is a summary of the cash flow of a company over a given period of time. The cashflow equals cash receipts minus cash payments over a given period of time or equivalently, net profit plus amounts charged off for depreciation, depletion, and amortization. These latter three items are added back because they do not represent any cash transactions. Depletion, which is similar to depreciation, accounts for the exhaustion of natural resources such as oil, timber, and minerals. The cash flow statement is a measure of a company s financial health and, in recent years, has become a very important feature of the annual report. 

---

This is the amount of cash passing through the hands of an organization in an accounting period. The cash flow statement analyses the sources and the disposition of cash during a given period. 

The reconciliation between the cash flow statement and the income and expense statement is as follows. Start with the 40,000 from the last line in the cash flow statement, subtract 20,000 for the depreciation expense, and add back the 30,000 mortgage loan principal payment (not an allowed expense). The result is the net after-tax earnings. Figure B.ll is a set of statements from a small oil company. The statement of operations lists revenue and expenses, whereas the balance sheet lists various assets, liabilities, and stockholders equity ( net worth ). So-called capital items such as buildings, equipment, oil and gas property, and various intangibles are assets. Operating costs are deductions from revenues for operations not including expenditures for capital items. 

Depreciation (negative on the income statement but will be added back on the cash flow statement) ... 

The income statement gives a good insight into the overall profitability and margins of a business. It has to be read carefully though, as several items listed are noncash charges such as depreciation that do not affect the cash flow of the business. Corrections for these items are made in the cash flow statement. 

The cash flow statement gives a summary of overall cash flows into and out of the business as a result of operating activities, investments, and financing activities. It is also usually reported for the past three calendar years. 

The differences between the income statement and the cash flow statement are shown as follows ... 

The most important of the new statements is the cash flow statement. As we have already pointed out, the income and expenditure account does not show expenditure on capital items, only their depreciation capital expenditure affects the balance sheet but the balance sheet does not give sufficient information to deduce how much this expenditure amounts to and how it was funded. The link which ties the balance sheet and the profit and loss account to the capital expenditure is the cash flow statement. A moment s examination of our student s financial statements will reveal that, because there is no cash flow statement, there is no explanation of where the money to purchase his CD player came from. 

The cash flow statement (Table 3.10) explains the change in cash between the dates of two successive balance sheets. Cash is defined as cash at bank and in hand and cash equivalents less bank overdrafts and other borrowings repayable within one year of the accounting date . 

The alert reader will recall that XYZ s balance sheet shows that, despite the fact that a loan of 50,000 has been paid off, the long-term debt has increased from 61,000 to 154,000 and that there is nothing in the cash flow statement to acconnt for this. It almost certainly arises from the acquisition of another company. The statement shows that 380,000 was spent on acquisitions the likelihood is that the compaity bought substantial debts, which were taken over by XYZ as part of the deal. 

Finally, understanding how each financial statement is not only related to each other, but connected to each other is important. Looking back to Tables 2.1 to 2.3, or viewing the modified financial statements (Table 2.4), the connection between the financial statements through certain line items is clear. Notice that ending cash on the cash flow statement is equal to cash on the balance sheet. Net income on the income statement is equal to the net income on the statement of cash flows. Net income from the income statement is added to retained earnings on the balance sheet, and thus stockholders equity increases, though this transaction is not quite as apparent. 

In addition to their historical use, cash flow statements are prepared as part of the budgeting process in order to identify the effects upon the cash facilities of the proposed activities for the period under review. A typical, simplified, statement would give the following information. 

Next, Figure B.9 represents a simplified cash flow statement for a retail computer store. The bottom number in the statement does not represent profit (income, earnings)—just the net of the cash flows, because the 30,000 mortgage payment... 

Cash flow statements are the easiest of the three main financial statements to understand because they are just like a checkbook. The amount of money coming in, less the amount of money going out, equals the net increase or decrease in cash from all sources. 

Consider a publicly traded company with products you are familiar with. Obtain a copy of the company s annual report. Examine and interpret the cash flow, income, and balance statements. Is the company profitable Did the company s cash position improve or degrade last year Did stockholder equity improve or degrade last year Calculate the ratios discussed in this section. Using library data or data off the Web, compare the companies averages to industry averages. In what ratios is the company s position favorable or not. 

First, they are a common denominator when discussing annual budgets, cash flow statements, and performance reviews. Any of those sets of information has a measurable impact on the value of the invested equity. 

The after-tax cash flow, which is generally found on a cash flow statement, adds the after-tax profit, purchase costs, and loan ptinciped payments and edso adds back in the depreciation expenses because depreciation is not a cash flow. The net present vrdue of the actued dollar after-tax cash flow is then computed at the market rate of 15%. The NPV for this example is 63,474.15. 

Table 16.5 Consolidated Cash Flow Statement for Chicago Chemicals in Millions of Dollars for the Calendar Year 2002...

Annual debt-servicing costs, exduding amortization (i.e., just interest and finance charges), are also considered as costs, but these are part of the finandal cash outflows and should not be considered as part of the operational cadi outflows in finandal analysis. However, both depreciation and interest costs affect the taxable income level and therefore tax payments and net aftertax income. It is therefore necessary to project annual income statements for the purposes of estimating tax payments prior to preparing a cash flow statement for either finandal analysis or discounted cadi flow analysis. 

Unlike the cash flow from operations on an accountant s statement of cash flows that is found in an annual report, free cash flow is independent of financing and nonoperating items. If a company reports a significant gain or loss that is not directly related to the company s normal core business, such as a one-time gain on the sale of equipment, this amount should be excluded from the free cash flow calculation for an accurate picture of the company s normal cashgenerating ability. Thus, FCF depends on sales revenue, operating costs and taxes, and required investments in operations. 

Although it is possible that the balance sheet inventory account may stay the same or increase from carrying additional safety stock, inventory costs have been accounted for in the cash flow forecast. Recall that inventory costs flow from the balance sheet to the income statement after the inventory has been used. In this example, the average inventory balance does not change, but since inventory has been assumed to have been used, the cost is reflected in operating expenses. 

To distinguish between cash flows and earnings, let us look at a grossly simplified set of financial statements for a company. The three statements are a... 

Cash flow and income statements identify the flow of funds through a business... 

The chapter considered the engineer s fear of financials and attempted to overcome it with a straightforward discussion of cash flow, income, and balance statements. The mathematics of these statements is simple arithmetic, but the confusion seems to come from not understanding a few key terms. The chapter also considered the utility of ratio analysis—what engineers might call dimensional analysis for companies—breakeven analysis, and the basics of the time value of money. Although a full discussion was beyond the scope of this chapter, the discussion served up the basics and may also serve to introduce more careful treatments in other courses or texts. 

It is not easy to get the necessary information to do a good cash flow analysis. Start with your checkbook, credit card statements, and tax records. The most difficult information to get will be what you spend on cash purchases. The best approach is to keep a journal for a couple of weeks to get a pattern and then estimate the amounts factoring in your personal experience. Income information should be available from your tax records. 

Accounting Keep the books Record financial transactions Prepare financial statements Manage cash flows Analysis of profitability... 

The three financial reports that are essential to the operation of any organization are the balance sheet, the income statement, and the statement of cash flows (Table 15-1). Please note that several other types of financial... 

Throughout the fiscal year, the inflows and outflows of cash are recorded in the statement of cash flows. 

Budgeted financial statements, often called pro forma financial statements, show how the pharmacy organization s financial statements will appear at a specified time if operations proceed according to plan. Budgeted financial statements include a budgeted income statement, a budgeted balance sheet, and a budgeted statement of cash flows. 

Prepare the financial statements (income statement, statement of owner s equity, balance sheet, statement of cash flows, etc.). 

Although working capital, the current ratio, and the acid-test ratio are effective ways to analyze a firm s liquidity, they should not be the only tools employed. The statement of cash flows is as viable as these ratios for analyzing liquidity. 

---