The Cash Flow Statement and Why it’s Important

We’ve gone over the income statement and the balance sheet. Now, it’s time to discuss the cash flow statement. These three statements make up the most basic financial information you should understand when looking at a company. The income statement handles what kind of money a company is making, the balance sheet handles the health of a company, and the cash flow statement helps you determine how good a company is at using their money.

Free Cash Flow

Free cash flow is the number one thing you should know about on a cash flow statement. Essentially, free cash flow is the money a company has to use however they would like. It is the excess cash possessed by a company. Free cash flow is calculated by taking the company’s operating cash flow and subtracting capital expenditures. All of these figures can be found on the financial statements.

Having a lot of cash is important for a company to remain healthy. By sitting on a good amount of cash, a company can help itself out if it has some negative earnings. In addition, the piles of cash can help pay down debt in a pinch.

Huge amounts of free cash flow is why companies like Apple are able to succeed. Even in a recession, I would be very confident that Apple would be able to continue being a strong company and would not have to fold in harsh economic times.

What Cash Flow Means to You

Cash flow is important because it allows you to get a general picture of how stable a dividend is. A dividend will fall under the ‘cash flow from financing activities.’ Taking a look at this, you don’t want to see really high external financing from a company. If something looks amiss, you can read how the money was spent on a company’s 10-k form.

A company with a lot of cash has invested their money properly and has been successful in their business ventures. This is the type of company we try to invest in at all times. If a company is highly profitable, is financially healthy, and generates a ton of cash, they are a great company. When this type of company is trading below its intrinsic value, you should be buying!

Combining your knowledge of financial statements, you should be able to now get a pretty good picture of what makes a good company financially. However, that it only part of it. In the future, we will discuss how to tell if a company has good qualitative features as well!

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