As you've learned, the Statement of Cash Flows often provides more useful information than the Income Statement or Balance Sheet. Cash is the lifeblood of a business; there's nothing more essential.
The Statement of Cash Flows reports the sources (incoming) and uses (outgoing) of a firm's cash. It gives you an inside look at how well the firm's operations are running, where its cash is coming from and where it's being spent. It shows how changes in a firm's Income Statement and Balance Sheet effected its cash.
The Statement of Cash Flows excludes any transactions that do not directly effect the firm's cash position. Credit sales and purchases, for example, are excluded along with non-cash adjustments such as depreciation. The effects of different accounting methods and policies are also eliminated.
Analyzing the Statement of Cash Flows can provide important strategic insights. A firm can be reporting healthy earnings on its Income Statement, but headed for bankruptcy. That was the case with Enron; while it was publishing financial reports that made Wall Street weak at the knees, its Statement of Cash Flows should have been raising eyebrows.
Remember also that the Statement of Cash Flows is organized around the three sources of and uses for a firm's cash.
- First is Operations. Is the firm's principal business purpose (selling rides on airplanes for Southwest Airlines) generating or using cash?
- Second is Investing. Is the firm buying or selling assets as a use or source for cash?
- Third is Financing. Is the firm using cash to repay loans or is it using loans to obtain cash? Did the firm raise cash by selling stock? Or did it use cash to pay dividends to its stockholders?
Studying the cash flows from these categories, their inter-relationships and cumulative effect provides insights into the value of a firm as a potential investment, supplier, customer or employer.
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