Major source and use of cash
- Cash flow analysis begins with evaluation of the firms’ sources and uses of cash from
- Operating
- Investing
- Financing
Operating cash flow (1)
- Positive operating cash flow can be generated by
- Firm’s earnings-related activities
- Decreasing non-cash working capital
- Liquidating inventory, receivables
- Increasing payables
- Check quality of firm’s earnings
- Stable relationship of operating cash flow and net income → quality earnings
- Earnings that significantly exceed operating cash flow → aggressive accounting choices
- Recognizing revenues too soon
- Recognize expense too late
- Variability of net income and operating cash flow
Investing cash flow (2)
- Increasing capital expenditure is indication of growth
- Reduce capital expenditure or sell capital assets to save or generate cash
- Operating cash flow should exceed capital expenditures
Financing cash flow (3)
- Issuing debt or equity to generate cash or not
- Using cash to repay debt, reacquire stock or pay dividends
Common size Cash Flow Statement
- Expressing each line item as a percentage of revenue
- Inflow/outflow of cash as a percentage of total cash inflow, outflows
- Useful in identifying trends and forecasting future cash flow
