How to Read a Financial Report by John A. Tracy & Tage C. Tracy

Author:John A. Tracy & Tage C. Tracy
Language: eng
Format: epub, pdf
ISBN: 9781119606482
Publisher: Wiley
Published: 2019-12-19T00:00:00+00:00

Exhibit 14.1 lists the balance sheet accounts of the company at the start and end of the year and includes a column for changes. (You might compare the informal balance sheet here with the formal layout of the balance sheet introduced in Exhibit 2.2.) This chapter focuses on the first section of the cash flows statement, which explains the determinants of the company’s cash flow from operating activities (i.e., its profit-making, or profit-seeking activities) during the year. Cash flow from operating activities is driven by changes during the period in the assets and liabilities affected by the revenue and expenses.

The main question on everyone’s mind seems to be: why doesn’t profit simply equal cash flow? In our example, the company earned $2,642,000 net income over the year just ended. Why didn’t earning this amount of profit generate the same amount of cash flow? The first section in the cash flows statement provides the answer to this question. It shows us that the company generated $3,105,000 cash flow from profit compared with its $2,642,000 net income for the year. Cash flow from profit is quite a bit higher than net income for the period.

Business managers have a double duty—first to earn profit, and second to convert the profit into cash as soon as possible. Waiting too long to turn profit into cash reduces its value because of the time value of money. Business managers should be clear on the difference between profit reported in the income statement and the amount of cash flow from profit during the year. Creditors and investors also should keep an eye on cash flow from profit (operating activities) and management’s ability to control this important number.

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