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2. Cashflowfrominvesting(CFI)isusuallynegativebecausethebiggestportion is the expenditure (outflow) for the purchase of long-term assets such as plants or machinery. But it can include cash received from separate (that is, not consolidated) investments or joint ventures. Finally, it can include the one-time cash inflows/outflows due to acquisitions and divestitures.
3. Cashflowfromoperations(CFO)naturallyincludescashcollectedforsales and cash spent to generate sales. This includes operating expenses such as salaries, rent and taxes. But notice two additional items that reduce CFO: cash paid for inventory and interest paid on debt.
The total of the three sections of the cash flow statement equals net cash flow: CFF + CFI + CFO = net cash flow. We might be tempted to use net cash flow as a performance measure, but the main problem is that it includes financing flows. Specifically, it could be abnormally high simply because the company issued debt to raise cash, or abnormally low because it spent cash in order to retire debt.
CFO by itself is a good but imperfect performance measure. Consider just one of the problems with CFO caused by the unnatural re-classification illustrated above. Notice that interest paid on debt (interest expense) is separated from dividends paid: interest paid reduces CFO but dividends paid reduce CFF. Both repay suppliers of capital, but the cash flow statement separates them. As such, because dividends are not reflected in CFO, a company can boost CFO simply by issuing new stock in order to retire old debt. If all other things are equal, this equity-for-debt swap would boost CFO.
In the next installment of this series, we will discuss the adjustments you can make to the statement of cash flows to achieve a more "normal" measure of cash flow.
Cash Flow
In the previous section of this tutorial, we showed that cash flows through a business in four generic stages. First, cash is raised from investors and/or borrowed from lenders. Second, cash is used to buy assets and build inventory. Third, the assets and inventory enable company operations to generate cash, which pays for expenses and taxes, before eventually arriving at the fourth stage. At this final stage, cash is returned to the lenders and investors. Accounting rules require companies to classify their natural cash flows into one of three buckets (as required by SFAS 95); together these buckets constitute the statement of cash flows. The diagram below shows how the natural cash flows fit into the classifications of the statement of cash flows. Inflows are displayed in green and outflows displayed in red:
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