Why the Statement of Cash Flows Matters

If you recall in my lesson on balance sheets, I directed you to seek out companies with high cash balances and low levels of debt. The statement of cash flows will highlight how successful a company has been in its efforts to generate cash and reduce debt. A good company will seek to generate positive free cash flow .

Free cash flow is the cash that a company has available for distribution to shareholders after payment of all its financing obligations. Despite borrowing $80.8 million and returning nearly $200 million to shareholders, Polo Ralph Lauren still generated $278.2 million in cash. Another way to look at it is that nearly half of the cash provided from Polo Ralph Lauren's operations was returned to shareholders. If you were to look at Polo Ralph Lauren's balance sheet, you would also notice that while its debt levels have risen, so has the company's amount of cash and equivalents.

How Does Cash Flow Relate to Liquidity?

The goal of a company -- besides creating free cash flow -- is to ensure that it has sufficient liquidity to meet its financial obligations and grow its business. Thus, from time to time, a company will have to access the banking or capital markets in order to increase its liquidity beyond the sources of its current operations or assets.

There are three basic ways in which a company can create liquidity beyond its operations or assets: Monetization of assets, issuance of equity and issuance of debt. Let's look at all three methods.