Cash Flow Statement

The Cash Flow Statement (also known as the Statement of Cash Flows) is one of the three core financial documents that every publicly traded company must release, alongside the income statement and the balance sheet. Think of it as a company’s financial diary, but instead of tracking feelings, it tracks cold, hard cash. While the income statement tells you about a company’s supposed profitability using accrual accounting rules, it can include non-cash revenues and expenses. The cash flow statement cuts through the noise. It shows precisely where a company's cash came from and where it went over a specific period (usually a quarter or a year). For value investing purists, this statement is often considered the most important of all, because as the saying goes, “revenue is vanity, profit is sanity, but cash is reality.” A company can report a huge profit but go bankrupt if it doesn't have the cash to pay its bills. This statement reveals the truth.

The story of a company's cash is told in three distinct acts. Understanding these sections helps you see the complete picture of how a company is managing its money.

This is the heart and soul of the business. CFO represents the cash generated from a company's normal, day-to-day business operations—the very reason it exists. For a bakery, this is the cash from selling bread and pastries, minus the cash paid for flour, sugar, and employee wages. A positive and growing CFO is the sign of a healthy, sustainable business. It's the engine that powers everything else. Most companies use the indirect method to calculate CFO. They start with net income (from the income statement) and then make two main adjustments:

• Add back non-cash expenses like depreciation and amortization. These were subtracted to calculate profit but didn't actually involve a cash payment.
• Adjust for changes in working capital. For example, if a company's customers are taking longer to pay their bills, its cash will decrease even if its reported sales are high.

This section is all about the company's long-term investment decisions. It shows how much cash the company is spending to grow and maintain its operations. Common activities here include:

• Cash Outflows: Buying property, plant, and equipment (PP&E), purchasing other businesses (acquisitions), or buying investment securities. This is often referred to as capital expenditure (CapEx).
• Cash Inflows: Selling off assets, such as old equipment or a factory.

Don't be alarmed by a negative number here. A large negative CFI often means the company is investing heavily in its future growth, which is exactly what you want to see in a healthy, expanding business. A consistently positive CFI, however, could be a red flag that the company is selling off its core assets to stay afloat.

This part of the statement reveals how a company interacts with its owners and lenders. It details the flow of cash between the company and its financiers.

• Cash Inflows: Raising money by issuing new stock or taking on debt.
• Cash Outflows: Repaying debt, paying dividends to shareholders, or conducting share buybacks.

CFF tells you a story about a company’s financial strategy. Is it relying on debt to fund its operations? Is it rewarding shareholders with cash? A company consistently raising cash through financing while its operations (CFO) are burning cash is a major warning sign.

For a value investor, the cash flow statement is a treasure map that can lead to undervalued gems and help avoid financial sinkholes.

Earnings can be managed and massaged by clever accountants. Companies can use various techniques to make their profits look better than they really are. Cash, however, is much harder to fake. A dollar is a dollar. The cash flow statement provides a crucial reality check on the profitability reported in the income statement. If a company boasts high net income but has weak or negative cash flow from operations, something is fishy.

The ultimate goal for many investors is to find companies that gush cash. The cash flow statement is the key to calculating one of the most powerful metrics in finance: Free Cash Flow (FCF). While there are several ways to calculate it, a common method is: FCF = Cash Flow from Operations - Capital Expenditures FCF is the surplus cash a company generates after paying for its daily operations and reinvesting in its future. This is the cash that's truly free to be used to pay down debt, reward shareholders with dividends and buybacks, or stockpile for a rainy day. It's the bedrock of most modern valuation methods, like the discounted cash flow (DCF) model.

By glancing at the cash flow statement, you can quickly assess a company's financial health. Ask yourself these simple questions:

• Is the company generating consistent, positive cash from its core operations (CFO)?
• Is the company investing for the future (negative CFI)?
• How is the company funding itself? Is it through its own operations or by taking on heaps of debt (high CFF)?
• Are its cash flows strong enough to support its dividend payments? If CFF shows a large outflow for dividends but CFO is weak, the dividend might be unsustainable.