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Chapter 5
The cash flow statement
 The cash flow statement is by far your most important, yet least understood and least used, financial statement. It shows where money comes from and where it goes during a particular period. Unlike the P&L, which measures earnings, the cash flow statement measures changes in cash balances.
To understand the difference, consider what happens when you haul a load. You complete the sale when you deliver the load, but the cash may not arrive for another 30 to 90 days. The P&L counts the revenue when you complete the haul; the cash flow statement counts it when you receive the cash. Likewise, you log an expense for tires on the P&L when you agree to buy them; you count it in the cash flow statement when you actually pay the dealer.
The P&L and cash flow statements cover the same period, but they are NOT just two different ways of telling the same story. Results can be positive on one statement and negative on the other. In the early years of a business, for example, it’s not unusual to show a profit and still need to raise lots of cash to pay the bills. Have your heard the phrase “negative cash flow”?
The cash flow statement usually begins with profit as reflected in the P&L and adjusts it to show only the portion of profit your company has actually received. Then it adds or subtracts cash generated or consumed by various company activities. The basic formula for the cash flow statement is:
Beginning cash
+/- Cash from (or to) operations, investments or financing
= Ending cash
Cash in any business comes from or is used by operations, investments or financing. Young companies typically obtain cash from financing sources, such as bank loans or capital infusions from owners, and use it to buy equipment (investment) and to cover shortfalls due to monthly losses and accounts receivable (operations). Later, when cash flow is positive, companies use cash from operations to retire debt (financing) or to buy more equipment (investment).
A closer look at a cash flow statement reveals the following format:
Net income
+/- Changes in working capital items
= Cash flows from (or to) operating activities
+/- Cash flows from (or to) investing activities
+/- Cash flows from (or to) financing activities
= Change in cash during the year
+ Cash at the beginning of the year
= Cash at the end of the year
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Years Ended December 31 |
1997 |
1998 |
1999 |
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Cash Flows from Operating Activities: |
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Net Earnings |
$225,180 |
$287,940 |
$327,180 |
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Adjustments to reconcile net earnings to net cash provided by operating activities: |
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Depreciation and amortization |
200,000 |
200,000 |
150,000 |
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Gain on sale of property and equipment |
- |
- |
- |
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(Increase) decrease in: |
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Trade accounts receivable |
(25,000) |
39,700 |
(81,700) |
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Receivables from related parties |
(5,000) |
3,000 |
(43,000) |
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Inventories |
(10,000) |
(12,000) |
(7,000) |
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Prepaid expenses and other |
(5,000) |
(2,000) |
(8,000) |
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Other assets |
- |
- |
- |
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Increase (decrease) in: |
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Trade accounts payable |
25,000 |
37,500 |
18,000 |
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Accrued expenses and other |
2,000 |
(9,000) |
17,000 |
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Net Cash Provided BY Operating Activities |
407,180 |
545,140 |
372,480 |
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Cash Flows from Investing Activities: |
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Proceeds from sale of property and equipment |
- |
- |
- |
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Purchase of property and equipment |
(125,000) |
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- |
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Proceeds (payments) of deposits |
- |
- |
(33,000) |
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Payments for increase in cash value of life insurance |
(5,000) |
(13,000) |
(9,000) |
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Net Cash Used by Investing Activities |
(130,000) |
(13,000) |
(42,000) |
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Cash Flows from investing activities: |
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Proceeds from long-term debt |
- |
- |
- |
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Principal payments on long-term debt |
(178,000) |
(27,000) |
(157,000) |
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Dividends Paid |
(29,180) |
(540,140) |
(194,980) |
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Purchase of treasury stock |
- |
- |
- |
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Proceeds from issuance of common stock |
- |
- |
75,000 |
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Net Cash Used by Financing Activities |
(207,180) |
(567,140) |
(276,980) |
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Net Increase in Cash |
70,000 |
35,000 |
53,5000 |
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Cash and Cash Equivalents, Beginning of Year |
175,000 |
245,000 |
210,000 |
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Cash and Cash Equivalents, End of Year |
$245,000 |
$210,000 |
$263,500 |
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Supplemental Schedule of Noncash Investing and Financial Activities: |
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Issuance of Debt to Acquire Property & Equipment |
$ - |
$222,000 |
$ - |
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SCU TRUCKING CO.
STATEMENT OF CASH FLOWS
Cash flows from (to) operating activities tell whether your trucking company’s day-today activities generated or consumed cash. Accountants use one of two methods to reconcile net income with cash inflow or outflow from operations:
Under the direct method, accountants show the actual cash collected and actual payments made. The resulting document looks just like a P&L, but it uses cash-basis rather than accrual-basis accounting. This approach is time-consuming and expensive; however, there is a simpler option.
Under the indirect method, accountants start with net income and add the change in current assets and liabilities during the period. This approach produces the same number as the direct method, it just does so indirectly. You can compute the change in these items by adding or subtracting the difference between the beginning and ending balances for each item.
Why this calculation produces the same result as the direct method isn’t obvious, so a very simple hypothetical example might help. Suppose your net income for the year is $500,000. Your accounts receivable was $800,000 at the beginning of the year and $1 million at the end. This means that the P&L includes $200,000 that didn’t arrive in cash, so the cash flow statement reduces net income by $200,000 to arrive at cash provided by operating activities of $300,000.
In the real world, there are many other current assets besides accounts receivable for which you must calculate the change in order to determine cash from operations: change in inventory, driver advances, prepaid items, accounts payable, accrued expenses, etc.
The bottom line under either method: Did your operating activities produce cash? If not, why not? You can answer these questions by reviewing changes in each current-asset category. Did your accounts receivable grow? Did you pay off old short-term debts? It’s very important to know the reason. Growing receivables could suggest a dangerously stretched credit limit, while retirement of debt could indicate that cash surpluses are coming.
Cash flows from (to) investing activities reflect how much cash you invested in trucks, trailers, other equipment and even stocks, bonds and other securities. Cash-down payments on trucks or trailers or for office equipment are a use of cash; proceeds from the sale of those items are a source of cash. Funds spent on “other assets” — non-compete agreements, loan costs, advances to subsidiary companies, franchises, etc. — would be listed here as a use of cash. Since companies rarely sell these items, they are almost never a source of cash.
Should the company build enough surplus cash to begin a temporary investing program, funds sent to the brokerage house or invested in stocks, bonds or short-term investments like CDs would be shown as a use of cash. Liquidation of these assets is a source of cash.
The pluses and minuses of investment cash flow can be difficult to analyze. Was your equipment purchase a reasonable market demand or a possibly dangerous overexpansion? Are you siphoning off much-needed cash for questionable investments, such as officer loans or risky new ventures? Is the company liquidating its brokerage investments to cover negative cash from operations? If so, how long can this continue? This can’t go on forever, so if the cash from operations is negative, how long can the investments support this?
Cash flows from (to) financing activities show what funds were used to pay debts or dividends or what funds came in from new loan proceeds or owner investment. If you took out a new $1 million loan, it will show up as a positive cash inflow. If you repaid $200,000 on a loan, it will show up as a use of cash. Many owner transactions will be reflected in this item, as will issuance of stock. Dividends and distributions will be a negative use of cash.
Seasoned analysts look for steady repayment of debt or reasonable proceeds from new debt issues. They also monitor owner withdrawals very carefully. Is the company distributing big dividends? If so, is the company retaining enough cash to finance future growth?
A supplemental section at the bottom of most cash flow statements tells you several things. Did the company sign any non-cash deals during the year? Often, equipment financing companies grant loans without down payments. The total amount of such transactions, if any, will be listed in this section to supplement the information in the investing activities section. Other supplemental disclosures list the total amount of cash used to pay loan interest or income taxes during the year.
In Summary
The cash flow statement measures the company’s sources and uses of cash for a period of time, usually a month, quarter or year, in tandem with the P&L. It converts an accrual basis P&L to cash basis. The formats may vary, but cash flow statements always show whether cash flowed to or from operations, investments and financing activities during the period.
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