Creating-a-cash-flow-plan-for-your-businessBusinesses of all sizes produce three types of financial reports: an income statement, balance sheet and cash flow statement.  The items on the income statement and balance sheet get the most focus from the financial press as they include things like earnings per share, capital expenditures and return on assets.  Looking past these items to the information on the cash flow statement can provide tremendous value.

To understand the cash flow statement you first must understand the three main sections:

Operating Cash Flows – this section highlights the cash profitability of the underlying business.  It focuses on the sources of cash (product sales, service agreements, etc) and offsets them with the expenses required to run the business.  It also shows the amount of sales in the period where completed on credit (i.e. the buyer hasn’t yet paid the company).  A quarter or two of negative operating cash flow may be explainable, but a company unable to consistently produce positive operating cash will likely not be around for very long.

Investing Cash Flows – this section of the statement shows how the company is investing their money.  Specifically are the investing in the business.  Are they spending cash buying new equipment or hard assets?  Have they sold business lines? These activities all are uses of cash and the cumulative results show up here.

Financing Cash Flows – here we see how the company is funding its operations.  Are they selling debt in the public market or are they buying back debt?  Have they issues more stock to the market?  These sources of cash are typically one-time in nature and can give an insight into the financial strength of the company.

Taken independently, each of these areas sheds light on the health of the business.  However, looking at them as a whole (along with the income statement) can be much more telling.  For example, a company may show positive earnings per share on the income statement but have negative cash flow from operations.  This may be a sign that the company’s underlying business isn’t necessarily producing enough cash to survive over the long-term.  The earnings may be a result of accounting manipulations.  In a situation like this it is likely that you will see a company selling assets in the investing cash flows section or issuing debt (or selling more stock).  These actions would result in bringing in the cash necessary to fund the shortfall in cash from operations!

Take the time and look over a cash flow statement you may be surprised by how certain companies are spending their money!

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