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Analyzing Cash Flow Statement Patterns

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  • 0:03 Cash Flow Statements
  • 0:48 Statement Components
  • 2:32 Example
  • 5:00 Overall Analysis
  • 5:23 Lesson Summary
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Lesson Transcript
Instructor: Deborah Schell

Deborah teaches college Accounting and has a master's degree in Educational Technology.

The cash flow statement identifies where a company obtained and used cash during a specified period of time. In this lesson, we analyze the patterns conveyed by this statement.

Cash Flow Statements

Mr. I. M. Rich runs a successful coffee shop, The Aroma Café. Business has been growing steadily over the past few years and profit has been increasing. He recently purchased a large amount of inventory as one of his suppliers was having a huge sale, as well as a new state-of-the art brewing system to allow him to attract more customers by offering exotic coffee blends. The problem is that Mr. I. M. Rich never seems to have any cash to pay employees and suppliers. He's even had to approach the bank for a short-term loan to cover his most recent payroll. He'd like to know more about where he is getting his cash and where it's being spent. Analyzing his cash flow might help Mr. I. M. Rich solve this problem.

Statement Components

While a balance sheet conveys the cash balance at a point in time, it does not show the source of the changes between last year's cash balance and this year's cash balance. A balance sheet is a financial statement that shows a company's assets, items that it owns; liabilities, items that it owes; and equity, the owner's investment in the business. A cash flow statement identifies sources and uses of cash as a result of three activities:

  • Operating activities
  • Investing activities
  • Financing activities

Operating activities represent the main source of cash for a company and arise out of regular business operations. For example, operating activities include collections from customers, payments to suppliers and employees and payments of interest and income tax to the government.

Investing activities relate to increases and decreases in long-term assets, which are used by the company over a period of time to generate revenue. Examples of investing activities include the purchase and sale of capital assets such as machinery and equipment, as well as collections of loans made to others. Next to operating activities, investing activities represent the most important source and use of cash.

Financing activities relate to activities that impact the long-term liabilities, items that a company owes, and shareholders' equity. Shareholders' equity is the difference between the company's assets, items it owns, and liabilities, items it owes. Examples of financing activities include issuing shares, paying dividends to shareholders, and borrowing money from a bank and paying it back.

Dividends represent a distribution of profit to the owners of a company; for example, its shareholders.

Example

The Aroma Café's cash balance last year was $75,000, and this year-end it was $10,000. Other than determining that his cash balance is $65,000 lower this year-end versus last year, Mr. I. M. Rich is unable to explain where his money has been spent. A summary of cash provided by and used in each activity for the current year is provided below.

Cash Flow Statement - 1

Analyzing Operating Activities

A company that has cash provided by operating activities is in a good position to purchase long-term assets and/or pay down its long-term loans. If a company also has cash provided by investing and financing activities, this situation could indicate that the company is stock-piling cash for a potential acquisition.

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