Analysis Of Cash Flow Statement

A critical analysis of cash flow statement is vital information for a company's management team and for both prospective and current stockholders. By understanding the basics of cash flow management, company management are better equipped to make financial decisions regarding such issues as whether or not to purchase or sell capital assets, taking on and repayment of debt, and plans for additional growth. Investors can use the information from a cash flow statement (or CFS) as part of making wise decisions about buying, holding, or selling stock in the company. The U.S. Securities and Exchange Commission, more commonly referred to as the SEC, was established in 1934 in response to the historic stock market crash of October 1929. The SEC is headed by five commissioners who are appointed by the President of the United States to serve staggered five-year terms. To help ensure nonpartisanship, another requirement is that no more than three of the commissioners can be from one political party. The first SEC chairman, appointed by President Franklin Delano Roosevelt, was Joseph P. Kennedy, the father of President of John F. Kennedy. According to the SEC's official website, their purpose is to "protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation." Therefore, publicly traded companies are required to file certain financial documents with the SEC on a regular basis. The Commission has enforcement authority to ensure that businesses comply with its regulations. Since the late 1980s, the SEC has required publicly-held companies, those that offer stocks to investors, to file cash flow statements along with other financial documents.

An analysis of cash flow statement basically shows where a business's money comes from and where the money goes. This differs from the economic information that will appear on other accounting documents such as net income or profit and loss statements, or balance sheets. Though an unscrupulous company may use fraudulent accounting techniques to hide negative economic information on some documents, it's nearly impossible to make up a fake CFS because this document reflects, to some extent, actual bank account information. There are three basic components to cash flow management, namely core operations, investments, and financing. The operations component is based on income received for goods and services while considering depreciation and inventory. The investing component considers the purchase and sales of capital equipment. The financing component considers debt payments and stock sales. Of course, the actual equations are more complex, but this is a brief overview. Much of the information on a CFS comes from the income statement which provides earnings information. It might be said that the CFS "translates" the earnings within a specific period of time (usually monthly, quarterly, and annually) to give a summary of relevant economic information. Another way of looking at this data is to see an analysis of cash flow statement in terms of an operating or earnings cycle: cash is exchanged by the business for goods and services which are offered to customers in exchange for cash which is used by the business for goods and services . . . ad infinitum.

After the October 1929 crash, political and financial leaders understood the need and the right for all investors, whether giant institutions or the common man on the street, to have accurate and current economic information. Only armed with this data, could wise investment decisions be made concerning what stocks to buy, what stocks to keep in one's portfolio, and when it was time to sell certain stocks. The SEC ensures that publicly held companies provide this information and that it is accessible to current and prospective investors. Like practically everything else, the technological advances of the internet have made it possible for people to access a wealth of economic information about a company without leaving their homes. Even those with just a small amount of money to invest can do so through certain trading companies. The documents that the SEC requires a company to file can often be found on the business's own website or at all other websites. On some sites, the prospective investor only has to enter a business's stock ticker symbol to find reports, documents, and stock prices (both current and historical). Stock market gurus offer all kinds of advice, both good and not-so-good, for picking up-and-coming stocks. Naturally, education is the best means for avoiding disaster. It's always beneficial to give heed to the Proverbs writer, who said, "The heart of the prudent getteth knowledge; and the ear of the wise seeketh knowledge" (Proverbs 18:15). The more the prospective investor knows and understands cash flow management, the more likely good investment decisions will be made. Get rich quick schemes seldom work, but a plan based on solid principles, including an understanding of proper analysis of cash flow statement, has a good chance of being successful.

Some investment advisors believe and teach that a good first step for determining whether a business is a good investment opportunity is to find out if the operating cash flow (OCF) exceeds the total net income. If not, it may turn out to be a dud. A second, related step is to determine the company's free cash flow (FCF). The prospective investor will need to calculate this amount by subtracting money spent on capital expenditures and acquisitions from the operating cash flow. This numbers should be recorded for the last year in which they are available as well as previous years. Businesses that are growing quickly will be investing most of their excess funds into expansion so the FCF may not be high. That's acceptable. However, a company with negative FCF should be considered a risky investment. The numbers needed for these two simple steps can be found on many investment websites by entering the ticker symbol in the proper box and then finding the appropriate link. Understanding the investment basics, including solid cash flow management, will help investors make good investing decisions.

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