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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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13
CASH FLOW FROM OPERATING
(PROFIT - MAKING) ACTIVITIES
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86 Cash fl ow from operating (profi t-making) activities
At this point we shift gears. Chapters 4 through 12 (except
for Chapter 6 ) walk down the income statement. Each chap-
ter explains how sales revenue or an expense is connected with
its corresponding asset or liability. In short, sales revenue and
expenses cause changes in assets and liabilities. You can t under-
stand the balance sheet well without understanding how sales
revenue and expenses drive many of the assets and liabilities in
the balance sheet.
This chapter is the fi rst of two that explain the statement of
cash fl ows , which is the third primary fi nancial statement reported
by businesses in addition to the income statement and balance
sheet. Exhibit 13.1 at the start of the chapter presents the cash
ows statement of the business we have discussed since Chapter
1 . Please take a moment to read down this statement. I ll make
you a wager here. I bet you understand the second and third sec-
tions of the statement ( investing activities and nancing activities)
much better than the fi rst section ( operating activities).
Exhibit 13.1 shows the balance sheets of the company at the
start and end of the year and includes a column for changes in
assets, liabilities, and stockholders equity. This chapter focuses on
the fi rst section of the cash fl ows statement, which presents cash
ows from the company s operating activities (i.e., its profi t - making
activities) during the year. As I m sure you recall, a company s
profi t - making activities are reported in its income statement.
The main question on everyone s mind seems to be why profi t
doesn t equal cash fl ow. In this example, the company earned
$ 2,642,000 net income over the year just ended. Why didn t
earning this amount of profi t generate the same amount of cash
ow? The fi rst section in the cash fl ows statement provides the
answer to this question.
The last line in the fi rst section is labeled Cash Flow from
Operating Activities (see Exhibit 13.1 ). Frankly, this is not the
best name in the world. I prefer to call it cash fl ow from profi t .
The term operating activities is accounting jargon for sales
revenue and expenses, which are the profi t - making activi-
ties or operations of a business. Much of the time I ll refer to
this line as cash fl ow from profi t, which is shorter and more
descriptive, I think. In any case, from the cash fl ows statement
we see that the company generated $ 3,105,000 cash fl ow from
profi t compared with its smaller $ 2,642,000 net income for the
year.
Business managers have a double duty rst to earn profi t,
and second to convert the profi t into cash as soon as possi-
ble. Waiting too long to turn profi t into cash reduces its value
because of the time value of money. Business managers should be
clear on the difference between profi t reported in the income
statement and the amount of cash fl ow from profi t during the
year. Creditors and investors also should keep an eye on cash
Profi t and Cash Flow from Profi t:
Not Identical Twins!
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