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How to Read a Financial Report: Wringing Vital Signs Out of the Numbers by John A. Tracy

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1
STARTING WITH
CASH FLOWS
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4 Starting with cash fl ows
Importance of Cash Flows: Cash Flows
Summary for a Business
Business managers, lenders, and investors, quite rightly, focus on cash
ows . Cash infl ows and outfl ows are the heartbeat of every business.
Without a steady heartbeat of cash fl ows, a business would soon die.
So, we ll start with cash fl ows. For our example I use a busi-
ness that has been operating many years. This established business
makes profi t regularly and, equally important, it keeps in good
nancial condition. It has a good credit history, and banks lend
money to the business on competitive terms. Its present share-
owners would be willing to invest additional capital in the
business, if needed. None of this comes easy. It takes good man-
agement to make profi t consistently, to secure capital, and to stay
out of fi nancial trouble. Many businesses fail these imperatives.
Exhibit 1.1 summarizes the company s cash infl ows and out-
ows for the year just ended, and shows two separate groups
of cash fl ows. First are the cash fl ows of its profi t - making activi-
ties cash infl ows from sales and cash outfl ows for expenses.
Second are the other cash infl ows and outfl ows of the business
raising capital, investing capital in assets, and distributing some
of its profi t to shareowners.
I assume you re fairly familiar with the cash infl ows and out-
ows listed in Exhibit 1.1 . Therefore, I ll be brief in describing
the cash fl ows at this early point in the book:
The business received $ 51,680,000 during the year from sell-
ing products to its customers. It should be no surprise that
this is its largest source of cash infl ow. Cash infl ow from sales
revenue is needed for paying expenses. During the year the
company paid $ 34,760,000 for the products it sells to custom-
ers. And, it had sizable cash outfl ows for operating expenses,
interest on its debt (borrowed money), and income tax. The
net result of its profi t - making activities is a $ 3,105,000 cash
increase for the year an extremely important number that
managers, lenders, and investors watch closely.
Moving on to the second group of cash fl ows during the year,
the business increased the amount borrowed on notes pay-
able by $ 625,000, and its stockholders invested an additional
$ 175,000 in the business. Together these two external sources
of capital provided $ 800,000, which is in addition to the inter-
nal $ 3,105,000 cash from its profi t - making activities during
the year. On the other side of the ledger, the business spent
$ 3,625,000 for building improvements, for new machines and
equipment, and for intangible assets. Finally, the business dis-
tributed $ 750,000 cash to its shareowners from profi t.
The net result of the cash infl ows and outfl ows is a $ 470,000 cash
decrease during the year. Don t jump to any conclusions yet; the
net decrease in cash in and of itself is neither good nor bad. You
need more information than just a summary of cash fl ows to come
to any conclusions about the fi nancial affairs of the business.
c01.indd 4c01.indd 4 3/2/09 10:14:47 AM3/2/09 10:14:47 AM
Starting with cash fl ows 5
EXHIBIT 1.1—SUMMARY OF CASH FLOWS DURING YEAR
Dollar Amounts in Thousands
Cash
Inflow
(Outflow)
Net Cash
Increase
(Decrease)
Profit-Making Activities
From sales of products to customers, including some sales made last year $ 51,680
)067,43(elas erut
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Other Sources and Uses of Cash
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For building improvements, new machines, new equipment, and intangible assets
(3,625)
(750)For distributions to stockholders from profit
Net cash change during year
$ 3,105
(3,575)
$ (470)
c01.indd 5c01.indd 5 3/2/09 10:14:47 AM3/2/09 10:14:47 AM

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