Welcome to week four of the Husky Investment Tournament! Continuing on with our analysis of the financial statements, we have moved on to the statement of cash flows, which shows us the cash inflows and outflows that go on within a company over the course of the year. You may have heard the statement that “cash is king” before. A company with strong cash flows will be in a better position than one that does not.
When is the statement of cash flows useful?
Looking at selected amounts of Company XYZ financials:
Sales 10 mil 20 mil
NI 1 mil 3 mil
We can see that the company has doubled its sales in the year 2020. Sounds good, right?
CASH FLOW STATEMENT
Operating CF 4 mil 1 mil
However, when looking at the statement of cash flows we see that their operating cash flow has decreased in 2020. That should raise red flags. Somehow the company was able to double their sales, but the cash they collected from operations went down. In this example, the company was probably really aggressive in their sales. They must have sold a lot more products on account rather than for cash.
To further check this assumption, you could look at the accounts receivable balance on their balance sheet. If the accounts receivable went up as well you have found out what this company is doing.
This further illustrates the fact of how all financial statements tie together and that it is important to understand each one when it comes to investing.
In this week’s video, Trevor Salata, current MTU business student and Applied Portfolio Management Program alumnus, explains the cash flow statement and how investors can use it to gauge investment decisions.