The statement of cash flows is one of the documents included in a company's annual report. It is broken down into three sections, including cash from operating, financing and investing activities. Operating activities include the cash that a company receives from selling its products and services. Investing activities are typically capital purchases, such as buildings and manufacturing plant equipment. Financing activities cover cash received or disbursed from the sale of investments, including common and preferred stock, bonds, and dividend payments.
A function of the statement of cash flows is to reveal where a company's cash balance is coming from. Companies that receive the majority of their cash receipts from operating activities typically have a financial advantage over those that rely on financing. The statement reveals whether a company is spending more than what it is making. For example, a red flag for an established firm might be a disproportionate amount of cash receipts from loans versus sales.
The statement of cash flows reflects whether a company's cash balance increased or decreased during a specified time period. At the bottom of the cash flow statement is a section that indicates the company's beginning and ending cash balances. Since cash is an indicator of a firm's liquidity and ability to pay its debts, sharp decreases may raise concerns among its investors. Decreases should not always be interpreted negatively, as they might indicate expansion. Major expenses listed under investing activities on the statement will usually reveal this type of occurrence.
Use of Cash
Each section of the statement of cash flows reflects expenses. These outflows show how a company uses its cash receipts. Expenses related to operating activities are usually the cause of returns and trade allowances. A high amount in this category might indicate issues with the quality of merchandise and customer satisfaction levels. Expenses related to financing activities are almost always dividend payments or capital losses on issued securities. High amounts of dividend payments might indicate that the firm's stock is focused on providing income to its investors.
The cash flow statement reveals whether a company is paying back its debt on long-term debt and re-purchasing its own stock. These types of activities show up in the financing section as purchases of common stock and loan repayments. If the amounts are high relative to the amount of cash receipts from operating activities, the company may be overstretched. It might indicate a need to increase sales volume, improper market pricing, or over expansion.
- Financial Accounting; Paul Kimmel, et al.
- Accounting Coach: Explanation of the Topic Cash Flow Statement
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