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Chapter 22 — Statement of Cash Flows
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Statement of Cash Flows


Many skilled investors consider cash flows to be the most accurate measure of a company’s income because cash flow is often different from the reported earnings, and cash flow cannot be manipulated the way that income can be manipulated. In fact, a company can show good earnings but still have negative cash flow (and vice versa). Cash flow is needed to run the business.


Where the cash comes from is important for similar reasons as the difference between operating income and non-operating income. When a company can’t generate enough cash from operations, it needs to find other sources for cash. This usually means issuing more debt or issuing more shares of stock. Either situation will hurt your investment.


i. Cash Flow from Operating Activities


To get a proper measure for how well the company is performing, you can compare the cash flow from operating activities to the income from operations. In most cases, these trends will be in the same direction but if cash flow declines while income increases, this could indicate that the company is having trouble making legitimate sales.


ii. Cash Flow from Investing Activities



Cash flow from investing activities should almost always be negative. It is primarily driven by capital expenditures. These are the investments that the company makes to grow the business. You will want this number to be at least as high as depreciation. If it is lower, then that means the company might be postponing critical long-term investments in order to inflate its short-term profit numbers.


iii. Cash Flow from Financing Activities


Cash flow from financing activities can help you measure how well the company is using its excess money (or making up its deficit, if it happens to be losing money).


Most healthy, well-managed companies will have negative financing cash flows. This is because negative cash flow means that the company is using its cash to repurchase company shares or pay down debt (improving its financial position), or paying out dividends to shareholders.


Long periods of large positive financing cash flows usually mean that the company is having trouble staying profitable. If the company having this problem is not a start-up, that could be a red flag.