The cash flow statement is organized into three
parts. The first, cash from operating activities, can alert one
to future declines in sales and earnings by signaling when a
company is having trouble selling inventory or collecting cash
it is owed, among other things. The second, cash from investing
activities, gives the reader lots of information from how much
the company earned in the stock market to whether it's cutting
back on capital expenditures. The third part, cash from
financing activities, indicates whether a company receives cash
infusions from outsiders, such as banks or shareholders.
Ideally, a company's operations should generate excess cash,
while its investing and financing sections show negative cash
flows because self-sustaining businesses can pay down debt and
finance new investments internally.
To understand how the cash flow statement highlights earnings
quality, one must understand the accounting rules that govern
the cash flow and income statements. Generally, companies record
the revenue that drives earnings when customers receive
merchandise, but before they pay. The cash flow statement
reflects how much cash is actually collected.
A bellwether for earnings quality is the ratio of net income on
the income statement to "cash from operating activities" on the
cash flow statement - generally, the closer the ratio of those
two numbers is to one, the higher is the quality of reported
Example cash flow statements
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