Cash Flow

Why is the cash flow statement so important?

It helps investors see what is going on inside of a company. It gives us a closer look that can tell us more than just what the income statement shows.

Example: Lehman Brothers

Between 2005-2007, their net income increased. This seems like a good thing, but if we look at their statement of cash flows, it is losing cash from operations. Each year they lost more cash from operations and from investing. Their new debt also increased. The net income number disguises what is going on in the inside, so if we did not see the cash flows, we would think that the company is doing well just based on the net income.

THe company reported rising amounts of net income. This is a good thing for shareholders, BUT you must see that the company failed to generate any cash from operations. The company borrowed to cover the cash deficits and ended up borrowing nearly 50 billion dollars. Later in 2008, they ran out of cash and went bankrupt.

So, it is possible for a company to show a healthy net income but not have the cash needed to pay its employees and suppliers. A positive net income on the income statement is INSIGNIFICANT unless the firm can translate its earnings into cash.

The cash flow statement gives us information about cash inflow and outflow over a period of time and is very important. It is another way of presenting a part of the balance sheet of the company. It shows the changes in the balance sheet accounts between periods.