Locked lesson.

Upgrade

About this lesson

The Cash Flow Statement is a financial report that shows how well the company was able to convert business activity into cash over some time period.  This lesson will focus on uses of cash.

Exercise files

Download this lesson’s related exercise files.

Cash Flow Statement Part 3.docx
113.9 KB Cash Flow Statement Part 3 - Solution.docx
61 KB

Quick reference

Cash Flow Statement Part 3

The Cash Flow Statement is a financial report that shows how well the company was able to convert business activity into cash over some time period.  This module will focus on uses of cash.

When to Use Cash Flow Statements

Cash Flow Statements are calculated for some time period, typically a month, quarter, or year.  It is often used in conjunction with the Earnings Statement and Balance Sheet to ensure a complete picture of financial health of a company.

Instructions

  • The Cash Flow Statement is focused on the generation and use of cash.
  • The Cash Flow Statement starts with the Net Income for the time period as calculated on the Earnings Statement.
  • The Cash Flow Statement looks at the change in the balance of business accounts over the time period to determine if they reflect an increase in cash or a use of cash.
  • The Net Cash Flow is added (or subtracted) from the original cash balance at the start of the period to determine the ending cash balance.
  • The Cash Flow Statement categorizes the accounts into three categories: Cash for Operating Activities, Cash from Investing Activities, and Cash from Financing Activities.
  • Operating Activities can become sues of cash if the business has been growing very fast or if the business is not managed well.  This category starts with the Net Income earned during the period.   If the Net Income was a loss, than it is a use of cash. 
  • Then changes to the amount of money in the operating accounts of Inventory, Accounts Receivable and Accounts Payable can become uses of cash. 
    • An increase in Accounts Receivable is a use of cash since the company is essentially loaning money to its customers.
    • An increase in Inventory is a use of cash since more money is needed to buy parts and store them on shelves.
    • A decrease in Accounts Payable is a use of cash since cash is being sent quicker to the suppliers.
  • Investing Activities are normally the primary use of cash.  In some cases, investments are sold to generate cash but that money is often immediately reinvested in something else.  Typical investments are:
    • The external purchase or acquisition of an asset such as land, building equipment, or even other companies.
    • The internal development of a new asset such as a new system or building a new building.
    • The acquisition of financial investments such as stocks or bonds.
  • Some typical Financing Activities are uses of cash.  However, as operating managers, we seldom are involved with financing activities.  These activities will use cash in several ways:
    • Repaying the principal on short-term or long-term loans.
    • Payments to bond holders.
    • The repurchase of the company’s own stock.
    • Distributing dividends to owners.

 

Hints and Tips

  • Many companies will subdivide some of these accounts for greater insight.
    • Investments may be divided into facilities, equipment, and acquisitions.
  • Do not confuse cash with profit.  You can increase cash and kill the business, or you can show a great deal of profit and run out of cash – especially in an accrual business.
  • There are often both sources of cash and uses of cash in each of the three categories.
Login to download
  • 00:02 Hi, I'm Ray Sheen.
  • 00:04 I'd like to talk to you one more time about the cash flow statement.
  • 00:07 This time I wanna to focus on the uses of cash.
  • 00:12 We have seen this cash flow several times.
  • 00:14 So I'll do a quick review.
  • 00:16 A cash flow statement is for a period of time.
  • 00:19 And it shows which accounts in the business generate cash, and
  • 00:22 which use cash.
  • 00:23 Sources of cash are positive numbers, and uses of cash are negative numbers.
  • 00:27 All the sources and uses are added together in the cash flow statement.
  • 00:30 To determine the net cash flow.
  • 00:32 The number is then added to the beginning cash balance.
  • 00:35 To determine the ending cash balance for the period.
  • 00:38 The various accounts are organized into three categories.
  • 00:41 Cash from Operating Activities, Cash from Investing Activities and
  • 00:44 Cash from Financing Activities.
  • 00:47 So let's discuss how the Operating Activities can become uses of cash.
  • 00:52 Recall that Operating Activities are the normal business operations.
  • 00:56 Many of these accounts in the Operating Activity category are shown with a plus or
  • 01:00 minus.
  • 01:01 That means the account might be a source or use of cash.
  • 01:04 Depending upon business operations, conditions, and
  • 01:07 how well the account is managed.
  • 01:10 I'll start with a negative net income.
  • 01:12 That means that instead of profits,
  • 01:14 the company generated a loss, that is a use of cash.
  • 01:18 Next, is the change to accounts receivable.
  • 01:20 If accounts receivable goes up, that is a use of cash.
  • 01:24 The company's essentially loaning more money to the customers.
  • 01:27 If the sales are flat and this happens.
  • 01:29 That means that the company has not been efficient at collecting payments.
  • 01:33 Now if sales are growing, that might be a negative number.
  • 01:36 Because the sales at the end of the period are much higher than at the beginning.
  • 01:41 If that is the case it may not indicate poor management.
  • 01:44 But it still reflects the company has had to use more cash
  • 01:48 to get that higher level of sales.
  • 01:50 Next, the change is to accounts payable.
  • 01:52 A decrease in the total of this account is a use of cash.
  • 01:56 That is because cash has been used to pay off bills faster than new ones came in.
  • 02:01 The last user of cash in the category of operating activities
  • 02:05 is changes in inventory.
  • 02:06 Inventory going up is a use of cash.
  • 02:09 Money is being spent to buy and bill products that are not being sold.
  • 02:13 That ties up cash.
  • 02:15 Let's move now to the cash from investing activities.
  • 02:18 And see how it can be a use of cash.
  • 02:21 Investing activities are those associated with acquiring and enhancing assets.
  • 02:25 For many companies, this category will contain the primary uses of cash.
  • 02:30 Because it is in this category that the new systems, facilities, or
  • 02:34 product activities are often captured.
  • 02:36 A company that has very low use of cash in this category
  • 02:39 indicates a company is not investing in the future.
  • 02:42 Cash is normally used in one of three ways in the investing activities.
  • 02:46 The first is to buy a new fixed asset.
  • 02:48 This could be land or new facilities, but
  • 02:50 it most commonly means buying new equipment.
  • 02:53 The equipment could be used in manufacturing or service operations.
  • 02:56 It could be new IT systems or security systems.
  • 02:59 It could be new equipment for a building.
  • 03:00 Such as a new air conditioning system, or a new solar panel to generate electricity.
  • 03:06 In addition to buying fixed assets, the cash might be used to create a new asset.
  • 03:11 This could be the construction of a new facility or
  • 03:13 the development of a new product and equipment.
  • 03:16 Keep in mind though that it is not the development of the equipment for sale.
  • 03:19 Rather it is the development of the equipment to make the product
  • 03:22 that are sold.
  • 03:23 Work with your finance person on this category.
  • 03:26 There's some accounting rules that must be followed.
  • 03:28 So that the cash is allocated properly between this category and
  • 03:31 cash from operating activities.
  • 03:33 The third type of investment is to buy financial investments such as stocks
  • 03:37 and bonds.
  • 03:38 The final category to discuss, is how financing activities can be a use of cash.
  • 03:43 Recall that these are the activities associated with debt and equity.
  • 03:47 And normally the finance department deals with these, not operating managers.
  • 03:51 But let's look at them anyway.
  • 03:53 The first two uses of cash are very straightforward.
  • 03:56 It's paying off debt, either short term or long term.
  • 03:59 This is the payment of principal, not interest.
  • 04:02 Interest payments are part of operating activities, and
  • 04:04 are reflected in the net income value.
  • 04:06 Next is payment to bond holders.
  • 04:08 Generally the payment of both the principal and interest,
  • 04:10 are considered financing activities.
  • 04:12 But there are some special rules and the finance people will take care of those.
  • 04:16 The next type of financing activity that can use cash, is the repurchase of stock.
  • 04:21 Stock buy back plans are very popular with some companies.
  • 04:25 When stock is bought back by a company, there are fewer owners remaining.
  • 04:29 That means that whatever dividends are declared.
  • 04:31 It will be split among fewer owners, so they will each get a bigger share.
  • 04:36 Which brings me to the final use of cash in financing activities.
  • 04:39 The payment of dividend distributions to owners.
  • 04:41 This is one form of return to the owners for their investment in the company.
  • 04:48 Uses of cash in the cash flow statement.
  • 04:51 Are a great indicator of the priorities of management and
  • 04:54 how well they're able to run the company.
  • 04:56 Are they paying off debt?
  • 04:57 Are they investing in the future?
  • 04:58 Or are they just trying to pay the bills?

Lesson notes are only available for subscribers.

PMI, PMP, CAPM and PMBOK are registered marks of the Project Management Institute, Inc.

Gift this course