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24 Financial Statement Analysis

stock amount is attributable to stock repurchases—in 2006 alone Colgate repurchased
$0.885 billion of its stock. Colgate’s treasury share amount largely explains its small
equity base.

Statement of Cash Flows

Earnings do not typically equal net cash flows, except over the life of a company. Be-
cause accrual accounting yields numbers different from cash flow accounting, and we
know that cash flows are important in business decisions, there is a need for reporting
on cash inflows and outflows. For example, analyses involving reconstruction and in-
terpretation of business transactions often require the statement of cash flows. Also,
certain valuation models use cash flows. The statement of cash flows reports cash in-
flows and outflows separately for a company’s operating, investing, and financing ac-
tivities over a period of time.
Colgate’s statement of cash flows is reproduced in Exhibit 1.8. Colgate’s 2006 cash
balance increases by $0.149 billion, from $0.341 billion to $0.490 billion. Of this increase
in net cash, Colgate’s operating activities provided $1.822 billion, its investing activities
used $0.620 billion, and its financing activities used $1.059 billion.

Links between Financial Statements
Financial statements are linked at points in time and across time. These links are
portrayed in Exhibit 1.9 using Colgate’s financial statements. Colgate began 2006 with
the investing and financing amounts reported in the balance sheet on the left side of
Exhibit 1.9. Its investments in assets, comprising both cash ($0.341 billion) and noncash
assets ($8.166 billion), total $8.507 billion. These investments are financed by both cred-
itors ($7.157 billion) and equity investors ($1.350), the latter comprising preference
and equity share capital ($2.051 billion) and retained earnings ($6.880 billion, which
includes accumulated comprehensive income and other items) less treasury stock
($7.581 million). Colgate’s operating activities are shown in the middle column of
Exhibit 1.9. The statement of cash flows explains how operating, investing, and financ-
ing activities increase Colgate’s cash balance from $0.341 billion at the beginning of the
year to $0.490 billion at year end. This end-of-year cash amount is reported in the year-
end balance sheet on the right side of Exhibit 1.9. Colgate’s net income of $1.353 billion,
computed as revenues less cost of sales and expenses, is reported in the income state-
ment. Net income less dividends paid explain movement in retained earnings reported in
the statement of shareholder’s equity. In addition, movement in accumulated compre-
hensive income is explained by other comprehensive income during the year. Finally,
movement in treasury stock arises both from issue and repurchase of treasury stock.
To recap, Colgate’s balance sheet is a listing of its investing and financing activities
at a point in time. The three statements that report on (1) cash flows, (2) income, and
(3) shareholders’ equity, explain changes (typically from operating activities) over a
period of time for Colgate’s investing and financing activities. Every transaction captured
in these three latter statements impacts the balance sheet. Examples are (1) revenues
and expenses affecting earnings and their subsequent reporting in retained earnings,
(2) cash transactions in the statement of cash flows that are summarized in the cash bal-
ance on the balance sheet, and (3) all revenue and expense accounts that affect one or
more balance sheet accounts. In sum, financial statements are linked by design: the
period-of-time statements (income statement, statement of cash flows, and statement of
shareholders’ equity) explain point-in-time balance sheets. This is known as the articu-
lation of financial statements.