Introduction to Corporate Finance

2: Financial Statement and Cash Flow Analysis

FIGurE 2.1 THE PATTERN OF CASH FLOWS THROUGH A COMPANY

(1) Operating flows

(2) Investment flows

(3) Financing flows

Payment

Payment

Depreciation

Purchase

Sale

Purchase

Sale

Borrowing

Repayment

Sale of shares

Repurchase of shares

Payment of cash dividends

Payment

Refund

Cash sales

Collection

Labour Accrued

wages

Materials

Accounts

payable

Production Overhead

Products or

services

Taxes

Operating (incl.

depreciation) and

interest expense

Sales revenue

Accounts

receivable

Debt

(short-term and

long-term)

Equity

Business

equity

Fixed assets

Cash

and

marketable

securities

2-2a THE COMPANY’S CASH FLOWS

Figure 2.1 illustrates the company’s cash flows. Note that in the process of evaluating a company’s cash

flows, analysts view cash and marketable securities as perfect substitutes. Both represent a reservoir of

liquidity that increases with cash inflows and decreases with cash outflows.

The company’s reservoir of liquidity, containing both cash and marketable securities, is affected by

changes in: (1) operating flows; (2) investment flows; and (3) financing flows.

A company’s total cash flows can conveniently be divided into: (1) operating flows; (2) investment

flows; and (3) financing flows. The operating flows are cash inflows and outflows directly related to the

production and sale of products or services. Investment flows are cash flows associated with the purchase

or sale of fixed assets. Clearly, purchases result in cash outflows, whereas sales generate cash inflows.

LO2.2

operating flows

Cash inflows and outflows

directly related to the

production and sale of a

company’s products or services

investment flows

Cash flows associated with

the purchase or sale of fixed

assets