📊Financial Information Analysis Unit 5 – Cash Flow Statement Analysis

What's a Cash Flow Statement?

• Financial statement that reports the cash generated and spent during a specific period
• Shows how changes in balance sheet accounts and income affect cash and cash equivalents
• Provides information about a company's liquidity, quality of earnings, and solvency
• Prepared using either the direct method (shows major classes of gross cash receipts and payments) or indirect method (starts with net income and adjusts for non-cash transactions)
• Complements the balance sheet and income statement by providing additional information about a company's financial health
• Helps investors, creditors, and other stakeholders assess a company's ability to generate positive cash flows, pay obligations, and fund growth

Why Cash Flow Statements Matter

• Cash flow is the lifeblood of a company and is essential for operations, investments, and financing activities
• Provides insight into a company's ability to generate cash from its core business operations
• Helps identify potential liquidity issues and assess a company's ability to pay short-term obligations
• Reveals the quality of a company's earnings by distinguishing between cash and non-cash components
• Assists in evaluating the sustainability of a company's growth and profitability
• Enables comparison of cash flow performance across different companies and industries
• Used by investors and analysts to make informed investment decisions and assess a company's financial health

Components of a Cash Flow Statement

• Operating activities: cash flows from a company's core business operations, such as selling goods or providing services
  • Includes cash receipts from customers, cash payments to suppliers, salaries, and other operating expenses
• Investing activities: cash flows related to the acquisition or disposal of long-term assets
  • Consists of purchases or sales of property, plant, and equipment (PP&E), investments in securities, and acquisitions or divestitures of businesses
• Financing activities: cash flows resulting from transactions with shareholders and creditors
  • Encompasses proceeds from issuing debt or equity, dividend payments, and repurchases of company stock
• Net change in cash: the sum of cash flows from operating, investing, and financing activities during the period
• Beginning and ending cash balances: the cash and cash equivalents at the start and end of the reporting period

Operating Activities Breakdown

• Cash receipts from customers for the sale of goods or services
• Cash payments to suppliers for inventory, raw materials, and other operating expenses
• Cash paid to employees for salaries, wages, and benefits
• Interest payments on outstanding debt
• Income tax payments to government authorities
• Other operating cash flows, such as rent, utilities, and insurance
• Adjustments for non-cash items, such as depreciation, amortization, and changes in working capital (accounts receivable, inventory, and accounts payable)
  • These adjustments are necessary when using the indirect method to reconcile net income to net cash provided by operating activities

Investing and Financing Activities

• Investing activities:
  • Purchase of PP&E (buildings, machinery, vehicles) to expand or maintain operations
  • Proceeds from the sale of PP&E no longer needed for the business
  • Acquisition of other companies or investments in joint ventures
  • Purchase or sale of marketable securities (stocks, bonds) for investment purposes
• Financing activities:
  • Proceeds from issuing short-term or long-term debt (notes payable, bonds)
  • Repayment of debt principal
  • Issuance of common or preferred stock to raise capital
  • Repurchase of company stock (treasury stock)
  • Payment of dividends to shareholders
  • Proceeds from the exercise of employee stock options

Interpreting Cash Flow Data

• Positive cash flow from operating activities indicates a company's ability to generate cash from its core business
• Negative cash flow from investing activities suggests a company is investing in its future growth (capital expenditures, acquisitions)
• Positive cash flow from financing activities implies a company is raising capital through debt or equity financing
• Consistently negative cash flow from operating activities may signal financial distress or unsustainable business practices
• A company with strong cash flow from operations and limited investing and financing activities is generally considered financially healthy
• Comparing cash flow statements over time can reveal trends in a company's cash generation and usage
• Analyzing cash flow in conjunction with the balance sheet and income statement provides a comprehensive view of a company's financial performance

Common Cash Flow Ratios

• Operating cash flow ratio: operating cash flow / current liabilities
  • Measures a company's ability to cover its short-term obligations with cash generated from operations
• Free cash flow: operating cash flow - capital expenditures
  • Represents the cash available for distribution to shareholders or reinvestment after maintaining and expanding the asset base
• Cash flow coverage ratio: operating cash flow / total debt
  • Assesses a company's ability to repay its debts using cash generated from operations
• Cash flow to net income ratio: operating cash flow / net income
  • Compares the cash generated from operations to the company's reported net income, indicating the quality of earnings
• Cash return on assets: operating cash flow / average total assets
  • Measures the cash generated from a company's assets, reflecting the efficiency of asset utilization

Real-World Cash Flow Analysis

• Walmart (retail): strong and consistent operating cash flows driven by efficient inventory management and high sales volume
• ExxonMobil (energy): significant investing cash outflows for capital-intensive projects, offset by substantial operating cash flows from oil and gas sales
• Amazon (e-commerce): historically negative free cash flow due to heavy investments in growth and infrastructure, recently transitioning to positive free cash flow
• Apple (technology): robust operating cash flows from iPhone sales and services, with substantial cash reserves for investments and shareholder returns
• General Electric (conglomerate): faced cash flow challenges in recent years due to underperforming business segments and high debt levels
• Berkshire Hathaway (holding company): substantial cash flows from operating subsidiaries and investments, used for acquisitions and stock purchases
• Ford Motor Company (automotive): cyclical cash flows influenced by vehicle sales, with significant investing outflows for product development and manufacturing