4.03 – Understanding All Elements of a Cash Flow Statement
Overview
Once past the first section of the statement of cash flows, the remaining sections are generally easier to understand. These sections report on the other sources of cash for the business and how it used its cash during the year.
Understanding Investing Activities
The second section of the cash flow statement reports the investment actions taken by a business’s managers during the year. Investments indicate what the future may hold for the company. Major new investments suggest expansion or modernization, while significant disposals can signal downsizing or strategic changes.
Long-Lived Operating Assets
Businesses need certain long-term assets to operate, like planes and trucks for delivery companies. When these assets wear out, they need replacing. To stay competitive, businesses also upgrade equipment. These investments, called capital expenditures, are crucial for the business’s future.
In the example, the business spent $750,000 on fixed assets, such as property, plant, and equipment. These expenditures are necessary for long-term operation and growth.
Disposals of Fixed Assets
Businesses often dispose of fixed assets that have reached the end of their useful lives. These assets might be junked, traded in, or sold. The proceeds from these disposals are reported in the investing activities section of the cash flow statement. These amounts are usually small unless the business is downsizing significantly.
Looking at Financing Activities
In the example, cash flow from operating activities is $7.593 million, and the cash outflow from investing activities is $750,000, resulting in a net cash increase of $6.843 million. However, the business also had financing activities, including repaying long-term debt, receiving additional investments from owners, and distributing profits to stockholders.
Financing Sources
Financing activities involve raising capital through debt and equity. This includes borrowing money, owner investments, and repaying debt. It also includes cash distributions to owners.
Debt Management
Most businesses have both short-term and long-term debt. Short-term debt is typically reported net, while long-term debt is reported in gross amounts, including total borrowings and repayments.
Owner Investments and Dividends
The financing section reports cash flows between the business and its owners. This includes new capital investments and profit distributions. In the example, the business issued $5 million in additional stock and paid $400,000 in dividends.
Example Analysis
The business generated $7.593 million in operating cash flow, raised $5 million through stock sales, repaid $1 million in long-term debt, spent $750,000 on capital equipment, and paid $400,000 in dividends. This resulted in a cash increase of approximately $10.493 million. The company plans to use this cash for a significant future acquisition, indicating strategic growth.
Active Reading of Financial Statements
When analyzing financial statements, especially the statement of cash flows, it’s essential to ask questions and think critically about the information presented. Understanding management decisions and their impacts on cash flow is crucial.
Dividend Analysis
For younger, rapidly growing businesses, dividends are typically low or nonexistent, as cash is needed for growth. Mature businesses, with stable operations, are more likely to pay dividends. In the example, the low dividend payout is strategic, given the company’s future investment plans.
Small and Privately Owned Businesses
Not all small businesses prepare a statement of cash flows, though it is recommended. For these businesses, adding back depreciation and amortization to net income can provide a rough estimate of cash flow from profit.
