Cash Flow

Article 25

Solving The Puzzle Of The Cash Flow Statement

Julie H. Hertenstein and Sharon M. McKinnon

T

he cash flow statement is one of the most useful financial statements companies prepare. When analyzed in a rational, logical manner, it can illuminate a treasure trove of clues as to how a company is balancing its receivables and payables, paying for its growth, and otherwise managing its flow of funds. But many readers seem to bypass the cash flow statement and head only for the old, familiar, comfortable income statement and balance sheet—despite the fact that the cash flow statement may provide considerable information about what is really happening in a business beyond that contained in either of the other two statements.

A Business Horizons tutorial.

There are several reasons why the cash flow statement may not get the attention it deserves. First, although it has been around in its present format since mid-1988, it is still considered the “new statement”; many managers were not exposed to it during their business schooling in financial analysis. If they were, they may have been taught how to prepare one but not how to interpret the story it tells. Second, the format of the “Cash Flow from Operating Activities” section of the statement can be challenging to 1

follow if presented in what is known as the “indirect” method. But perhaps most daunting to many is the mistaken idea that it takes a very sophisticated analysis of complicated ratios and relationships to use a cash flow statement effectively. Contributing to this notion are numerous business journal articles that have appeared in the past decade. They promote the value of this statement when appropriate cash flow ratios are used in statistical packages, such as those used to predict bankruptcy. Present day textbooks, when not merely teaching students to prepare the statement, also concentrate on describing how ratios such as “free cash flow to net income” can be derived, but say little about what...