Monday, 15 June 2015

Understanding Financial Statements (Part 3) - The Cash Flow Statement

For other parts on this topic:

Part 1: The Income Statement
Part 2: Balance Sheet
Part 4: Financial Ratios

This is the third part of Understanding Financial Statements, this part will cover the cash flow statements section of the financial statements. The cash flow statement shows the net inflow and outflow of cash in the various items stated. It begins with the profit before income tax. After adjustments for items on the profit and loss statement which do not actually affect cash flow, for example, depreciation and amortization as they do not physically remove cash from the company, the operating cash flow before interest, income tax and working capital is obtained. This is where we shall begin

A company that doesn't generate cash isn't worth very much, is it?
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Cash used in operating activities

This represents the amount of money that the company has gained or lost through its operating activities. From the operating cash flow before interest, income tax and working capital, income tax and interest that has been paid in the reporting period (it can be deferred to future periods), we get operating cash flow before changes in working capital.

The working capital component comprises of trade receivables, trade payables and inventory among some other industry-specific items. The changes in working capital show the changes in the cash conversion cycle of the company (the amount of time taken for the company to receive its money after making payment). This would affect the amount of short-term borrowings that the company has to take up to meet its short-term obligations

Cash used in investing activities

This has two main groups of items, those involved with acquiring property, plant & equipment (PP&E) and those involved with the companies under the group (main company). Money used in acquiring PP&E is the cash flow statement equivalent of depreciation and amortization, as they both represent the same thing, except that PP&E in the cash flow statement would show all of the money outflow on one statement while depreciation and amortization is usually spreading the cost of the PP&E over the usable life of the item or as it is devalued.

Money involved with the companies of the group would be in areas such as acquisition of other companies, increasing the ownership in the company or extension of loans to these comapnies.

Cash used in financing activities

This section includes the amount of money paid out in dividends to the owners of the parent company and the minority interests as well as the draw down of loans, issuance of bank notes, rights issues and repayment of loans or notes.

Net Change in Cash = Cash used in operating activities + Cash used in investing activies + 
                                       Cash used in financing activities


With this part, we end the focus on the numbers presented in the financial statements and in the next part, we will be moving on to the various ratios commonly used to assess the health of a company.

For the next and final part of this topic:

Part 4: Financial Ratios

For the previous parts of this topic:

Part 1: The Income Statement
Part 2: Balance Sheet

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