Cash Flow

Section: Cash Flow Statement Analysis Estimated study time: 45 minutes Content: The cash flow statement reconciles the change in a company's cash and cash equivalents over a reporting period. Because accrual accounting allows revenue and expense recognition that differs from cash receipt and payment, net income and operating cash flow can diverge significantly. A company can report positive net income while running out of cash (if it is building up receivables or inventory faster than it collects), or generate strong cash flow while reporting a net loss (if depreciation and amortization — non-cash charges — are large). The cash flow statement is divided into three sections: (1) Operating Activities, (2) Investing Activities, and (3) Financing Activities. A healthy business typically shows positive and growing operating cash flow, negative investing cash flow (from capital expenditures and acquisitions), and variable financing cash flow. Operating cash flows (CFO) can be presented using the direct method or indirect method. The direct method shows actual cash receipts from customers and cash payments to suppliers and employees — highly intuitive but rarely used in practice. The indirect method starts with net income and adjusts for: (1) non-cash charges (add back depreciation and amortization), (2) gains and losses (subtract gains, add back losses on asset sales, since the cash proceeds appear in investing activities), and (3) working capital changes (increases in current assets other than cash are cash outflows; increases in current liabilities are cash inflows). For example: if accounts receivable increase by $10M, the company recognized $10M more in revenue than it collected in cash — a $10M deduction from net income in the CFO reconciliation. Investing activities (CFI) include: purchases and sales of property,…