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The same accounting data is used in preparing all three statements, but each takes a company’s pulse in a different area.
The cash flow statement discloses how a company raised money and how it spent those funds during a given period. It is also an analytical tool, measuring an enterprise’s ability to cover its expenses in the near term. Generally speaking, if a company is consistently bringing in more cash than it spends, that company is considered to be of good value.
A cash flow statement is divided into three parts: operations, investing and financing.
The following is an analysis of a real-world cash flow statement belonging to Target Corp. Note that all figures represent millions of dollars.
Cash from operations: This is cash that was generated over the year from the company’s core business transactions. Note how the statement starts with net earnings and works backward, adding in depreciation and subtracting out inventory and accounts receivable. In simple terms, this is earnings before interest and taxes (EBIT) plus depreciation minus taxes.
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Interpretation: This may serve as a better indicator than earnings, since noncash earnings can’t be used to pay off bills.
Cash from investing: Some businesses will invest outside their core operations or acquire new companies to expand their reach.
Interpretation: This portion of the cash
flow statement accounts for cash used to make new investments. as well as proceeds gained from previous investments. In Target’s case, this number in 2006 was -4,693, which shows the company spent significant cash investing in projects it hopes will lead to future growth.
Cash from financing: This last section refers to the movement of cash from financing activities. Two common financing activities are taking on a loan or issuing stock to new investors. Dividends to current investors also fit in here. Again, Target reports a negative number for 2006, -1,004. But this should not be misconstrued: The company paid off 1,155 of its previous debt, paid out 380 in dividends and repurchased 901 of company stock.
Interpretation: Investors will like these last two items, since they reap the dividends, and it signals that Target is confident in its stock performance and wants to keep it for the company’s gain. A simple formula for this section: cash from issuing stock minus dividends paid, minus cash used to acquire stock.
The final step in analyzing cash flow is to add the cash balances from the reporting year (2006) and the previous year (2005); in Target’s case that’s -835 plus 1,648, which equals 813. Even though Target ran a negative cash balance in both years, it still has an overall positive cash balance due to its high cash surplus in 2004.