You gotta love having cash in your pocket. Something about it makes you feel and appear powerful. Companies with cash have the same aura. Having cash implies a strong, well-run business. "Cash is king" for a reason: You need it to run the shop. And if you come across a company that doesn't have any cash, you might want to take your investment elsewhere -- or at least consider shorting the stock. Over the past couple of months, we've taken a look at how to evaluate companies' financials through their
10-Qs , balance sheets and income statements . There's one more big one to examine: the cash flow statement. It will help you determine just how much cash is available for a company's business. Since the cash flow statement explains the company's overall cash position, many will argue that it is the most important of the three statements. And while it clearly offers a ton of info, it's not perfect. Sure, it shows the cash coming in and out, but it doesn't show the stuff the company owes -- such as its liabilities. Think of your upcoming rent payment. Your checkbook doesn't actually report that bill until you pay it. And since the cash flow statement is like one big checkbook, you won't find upcoming liabilities here. You'll need the balance sheet for that. Same goes for previously purchased assets. They hit the cash flow statement in the period they were purchased. But after that, they just sit on the balance sheet as well, so if you're looking at a company for the first time, the cash flow is not going to give you info about its asset accounts. But regardless of its shortcomings, this statement is still invaluable. The days of investing in cashless companies blew up with the tech bubble. Your company better have money to pay the bills, expand its business and issue you a dividend. To watch Tracy Byrnes' video take of this column, click here .
The cash flow statement is divided into three parts, so let's go through each of them.
Keep the Shop OpenFirst look at the "net cash flow from operations" number, which is probably the most significant number on the statement. It tells you whether the company can afford to run its day-to-day business, says Ed Ketz, associate accounting professor at Penn State University. Net operating cash is basically all the money a company collected from its paid sales (not the stuff still sitting in the accounts-receivable account), less the cash it needs to keep the front door open. Clearly, you're looking for a positive number. If it's red, put on your skeptic's hat. Compare it with the prior period and the year-ago period. "There's really no need to crunch any numbers yet; just eyeball it and get a sense of the trend," says Dan Noll, director of accounting standards at the American Institute of Certified Public Accountants. If you see some sort of steady or positive trend, then you can take comfort that the company can probably afford its affairs. But be skeptical of big pops or one-time items, such as tax refunds, which are also reported in this section. We all know that you can't depend on getting a tax refund every year. Also be cautious of "net cash from discontinued operations." It's basically the cash (or loss of cash) from a part of the business that has been discontinued, but is still running. So, that segment is not completely shut down or sold, but it will be soon. So if that division is making money, know that it's going to go away. If it's been losing money, then disposing of it will help the company increase operating cash once it's shut down. If net operating cash is negative or decreasing, dig harder. What's going on? If it's a start-up, then the company may be using cash to get the business off the ground. But if it's an established company with decreasing operating cash, that could be a sign that sales are slumping or that things are not being properly managed.
Investing and FinancingBefore we dive into the next two sections, do another quick eyeball check. Scroll down to the bottom of the cash flow statement and look at the change in total cash from the beginning of the period to the end of the period, says Noll. That's the "net change in cash and cash equivalents." Again, you'd like to see it increasing over the period. So if the company's overall cash balance is down, delve into the next two sections to understand why. Cash flow from investing activities shows the cash coming in and out from income-producing assets. So if your company bought or sold a new business or division, you'd see the cash outflow or inflow here. Same goes for cash spent buying or selling equipment. In addition, if your company has an investment account that it uses to make a little extra dough with its unused money (i.e., a money market account), you'll see that gain or loss here too. Now move on to the cash flow from financing section. It basically shows the flow of cash between the folks it owes money to: you, the shareholder and creditors. Negative numbers are not unusual in this section, especially if the company is making loan payments, issuing dividends or buying back stock. Those are big cash outflows. Still, again, be skeptical. Flip to the debt footnote and understand what loans are coming due. Then be sure to read up on the company's dividend policy. You want to understand when cash is coming out of the company and why.
Crooked Cash FlowMost accounting trickery can be found on the balance sheet and income statement, such as reporting fictitious sales to boost revenue or letting old accounts receivables linger to keep the asset balance high. But the cash flow statement can also have some big mistakes.
Pier One ( MSFT), for instance, recently had a cash misstep. It attempted to report a cash inflow in the cash-from-operations section that should have been reported in its investing section. The outcome was an inflated operating cash number. The Securities and Exchange Commission caught on and insisted the company restate. The retailer's revised net operating cash fell 64% in 2005, from $142.2 million to $51.1 million, according to the Accounting Observer. Similar cash flow shenanigans have happened at GM ( GM), Popular ( BPOP) and Blockbuster ( BBI). All have had to restate. "And, no surprise, almost every restatement lowers cash from operations," says Ketz.
So read these statements and hold your company accountable. Your company needs cash, and if there's a problem, you should invest your hard-earned money elsewhere.