Statement of Cash Flows Explained

Check out this video on my favorite financial statement…

VIDEO SUMMARY

This video is about the Statement of Cash Flows. I am very excited to make this video today. Now I might get a lot of angry comments for saying this, but in my opinion, the statement of cash flows is the most important financial statement. Let me explain how important I think it is. I read a lot of company annual reports (mostly just for fun). I read them like story books. But when I pick up a new annual report, the first page I flip to every single time, is the statement of cash flows. I read that first, and then I go back and read the rest of the annual report. That’s how important it is. I could talk about the statement of cash flows for days. But I’m not going to do that, because I want to make a short, to the point video, and talk about the statement of cash flows from a financial perspective. What I mean is, if someone from outside the company were to pick up an annual report, and look at the statement of cash flows, what key points should they take away from the document.

Let’s start by talking about why it is so important. Cash is a very special type of asset. Out of all the assets in an organization, cash is the most liquid. It’s not like inventory, equipment, AR. Cash can be spent quickly and turned into other items. So it’s very important to keep your eye, on what is happening with cash. Because if something fishy is happening in the company, it is going to show up in the cash first. It’s kind of like a barometer for what is going on with the company.

So lets look at a statement of cash flows. You always have three sections: Operating, Investing, and Financing. And any economic activity of the company can fit in these three areas.

• Operating deals with the core business activities. If you are selling a product or a service. Are those sales bringing in cash or losing cash for the business?
• Investing deals with investing in the business. Like buying a piece of land, or selling a piece of land.
• Financing deals with financing activities like issuing debt, or paying off debt. Or issuing stock. Or paying out dividends

So looking at these three areas. There are three questions you should ask yourself.

• Is the overall cash for the business increasing or decreasing and by how much? This is simple enough to figure out, and it should match what is shown on the balance sheet. Now I’m not saying one is good or bad. You just need to understand what is happening. Because what we’re doing, is building a story around what is happening in this business.
• Where is the cash coming from?
• Where is the cash going to?

So you will always have cash coming in from some places and cash going out of other places, and you should always be aware of what is happening with the cash.

So let me share with you the ideal situation. Here is what business owner’s generally like to see. We would like to see operations generating a lot of cash. So sales of a product or a service is being converted into cold, hard cash in your bank account. So that should be a cash inflow. Then you want to see a cash outflow in investing. Because you want to see a business investing in future growth opportunities, so operations can bring in even more money in the future. Then you also want to see a cash outflow in financing. So operations generated so much cash that it not only covers future investment, it also covers paying out dividends to your shareholders. So that’s one example of a healthy statement of cash flows. I hope you can see that cash, this very liquid asset, is flowing around your business. And the statement of cash flows is showing you where the cash is flowing.

Now let me give you another example. You might look at your balance sheet and see that cash has increased during the year. And you might say wow, look at the growing cash, how great is that. But hold on! Not so fast! Because when we take a closer look at our statement of cash flows, we might see that the reason we have so much cash, is because we took out a massive bank loan. Not only that, we might have brought in all this cash from financing, to cover massive losses in operations. Not only that, our massive losses in operations, might not be showing up on the income statement by booking sales that we haven’t actually received the cash for yet. So this is a much different story.

So there are going to be lots of different variations on statements of cash flows. If you look at 10 different companies, they are all going to be vastly different. And the point is not that one is better than the other. Businesses are going to be at different points in their life cycle, and so their statements of cash flows are going to look different. The point is you should understand the story about what is going on with the cash, because that can tell you a lot about a business.

So to recap, we talked about the statement of cash flows.

• We discussed why cash is important.
• We discussed the three different sections.
• We talked through three questions you should ask yourself about a statement of cashflows.
• And we talked through two examples of what a statement of cash flows might look like.

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Neither Zach De Gregorio or Wolves and Finance Inc. shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.