The use (and misuse) of cash flow statements

Abstract

Analysts are required to analyze financial reports of the companies they track. One of the key elements of analysis is the analysis of cash flow statements. Cash flow statements throw light on the operating, investment, and financing decisions of a firm. A careful analysis of cash flow statement enables an analyst to pinpoint "good news" and "bad news" as well as draw overall conclusion. This chapter has the following objectives: • Highlight why analysts focus on cash flows • Explain the structure of a cash flow statement • Present a framework for analyzing cash flow statements A balance sheet gives us the snapshot of the financial condition of a firm measured on a particular date (say financial closing date). It is a stock concept. An income statement, on the contrary, is a flow concept. It tells us how the owners' equity changed during the accounting year. A third statement, called the funds flow statement, shows the sources from which funds were raised between two balance sheet dates and how they were deployed. Funds flow statement is also called statement of changes in financial position. It enables us to answer such questions as the following: • How did the firm finance capital expenditure-Was it by way of equity or debt or some combination? • How is the firm financing its dividend payments? How was it possible to distribute dividends in excess of profits for the current year? • Is the company building up or slashing down inventory? © 2009 Springer-Verlag Berlin Heidelberg.