Cash Flow Statement

Direct Method

The direct method, also called the income statement method, reports major classes of operating cash receipts and payments. Using this method of preparing a cash statement starts with money received and then subtracts money spent, to calculate net cash flow. Depreciation is excluded altogether because, although it is an expense that affects net profits, it is not money spent or received.

Indirect Method

This method, also called the reconciliation method, focuses on net income and the net cash flow from operations. Using this method one starts with net income, adds back depreciation, then calculates changes in balance sheet items. The end result is the same net cash flow produced by the direct method. The indirect method adds depreciation into the equation because it started with net profits, from which depreciation was subtracted as an expense.

Regardless of whether the direct or the indirect method is used, the operating section of the cash flow statement ends with net cash provided (used) by operating activities. This is the most important line item on the cash flow statement. A company has to generate enough cash from operations to sustain its business activity. If a company continually needs to borrow or obtain additional investor capitalization to survive, the company's long-term existence is in jeopardy.

FINANCING AND INVESTING SECTIONS

The cash flows, in and out, resulting from financing and investing activities are listed in the same way whether the direct or indirect method of presentation is employed.

Cash Flows from Investing

The major line items in this section of the cash flow statement are as follows:

• Capital Expenditures. This figure represents money spent on items that last a long time such as property, plant, and equipment. When capital spending increases, it often means the company is expanding.
• Investment Proceeds. Companies will often take some of their excess cash and invest it in an effort to get a better return than they could in a savings account or money market fund. This figure shows how much the company has made or lost on these investments.
• Purchases or Sales of Businesses. This figure includes any money the company made from buying or selling subsidiary businesses and will sometimes appear in the cash flows from operating activities section, rather than here.

Cash Flows from Financing

The major line items in this section of the cash flow statement include such things as:

• Dividends Paid. This figure is the total dollar amount the company paid out in dividends over the specified time period.
• Issuance/Purchase of Common Stock. This is an important number because it indicates how a company is financing its activities. New, rapidly growing companies will often issue new stock and dilutes the value of existing shares in so doing. This practice does, however, give a company cash for expansion. Later, when the company is more established it will be in a position to buy back its own stock and in this way increase the value of existing shares.
• Issuance/Repayments of Debt. This number tells you whether the company has borrowed money during the period or repaid money it previously borrowed. Borrowing is the main alternative to issuing stock as a way for companies to raise capital.

The cash flow statement is the newest of the three fundamental financial statements prepared by most companies and required to be filed with the Securities and Exchange Commission by all publicly traded companies. Most of the components it presents are also reported, although often in a different format, in one of the other statements, either the Income Statement or the Balance Sheet. Nonetheless, it offers the manager, investor, lender, and supplier of a company a view into how it is doing in meeting its short-term obligations, regardless of whether or not the company is generating income.

 PREV  1 | 2 

Read more:

Sign-up for our Finance Newsletter

Email Address: