Interpreting a Statement of Cash Flows


How are financial statements used as a management tool?

The three most frequently needed financial statements for assessing the financial health and overall performance of a company are: its balance sheet, a statement of cash flows, income statement. Though all these statements are prepared using the same data, each gives an insight to different areas of the company.

A statement of cash flows reveals how the company collected funds and spent the same during a particular period of time. It presents a systematic way of assessing how long it may take for the company to recover its outlay. It’s not difficult to make out that a company that continues to generate cash time and again will be worthwhile.

A statement of cash flows comprises of three parts, namely investing, operations and financing. Here is an actual cash flow statement of Target Corp. All figures are in million dollars.

Cash from operations: It represents cash that the company generated from its core operations during the year. Here, you can see the net earnings of the company appear in the beginning of the statement, followed by addition of depreciation and deduction of inventory and receivable amounts. This simply means that this is company’s income before taxes and interests.
Interpretation: It can provide a better pointer than earnings as non cash income can’t be utilized for payment of bills.

Cash from investing: It’s not unusual for companies to invest funds in business not directly connected to their main business. For instance, a company may invest for acquiring another company to enlarge their operations.
Interpretation: This part of the statement of cash flows gives an account of funds that the company employed for making new investment and also the earning from preceding investments. This figure in case of Target, for the year 2006 was -4693, indicating that the company made substantial investments in projects that it expected to grow in future.

Cash from financing: The last section here points out cash movement from financial activities. The financial activities include taking a loan and issuance of stock to fresh investors. Dividends to existing investors are also included here. For 2006, once again, Target shows a negative figure of -1004, but it need not be misinterpreted as the company paid its old debt of 1155 and a dividend of 380 and also repurchased its stock worth 910.
Interpretation: The last two items should keep the investors happy as they earned dividends. That shows Target is optimistic of the performance of its stock and would like to retain it for enhancing profit of the company in future.

The last step for evaluating cash flow will be to add cash balances from the previous year 2005 and the reporting year. In this case it is -835+1648=813. So, you can see that despite having shown negative cash balance for both the years, the company has had a positive balance finally as it had lofty cash surplus during 2004.


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