Hi friends.
“Total Cash Flow from Operations” is an important subtotal found on the Statement of Cash Flows. This subtotal amount taken from each subsequent cash flow statement basically represents cash earnings for the latest period.
The latest Income Statement reflects earnings for the latest period too. But the Net Income (or earnings) number is based on measuring earnings inflows and outflows by a metric other than cash flow. That other metric is one known as accrual flow. I’ve discussed this accrual concept a good while back in a brief series of blog posts.
Ultimately cash is the only asset that really matters in that all economic activity is transacted in cash. So the generation of cash by any business is the most critical factor in measuring the real success of the business. Only the Statement of Cash Flows reveals what’s happening to company cash from period to period. And only the portion of the cash flow statement that reveals cash flows resulting from operating activities tells us how the company is doing in terms of generating cash from its core business activity.
The Statement of Cash Flows also has an investing section that shows cash flows resulting from investing in new long term capital assets and from selling the same; and it has a financing section that shows cash flows resulting from raising long-term money (financing) and from repaying debt. Again, only the Operating section of the Statement of Cash Flows gives us a picture of how much cash profit is resulting from a company doing business.
So, it is wise to always review the Statement of Cash Flows, from period to period, with emphasis on the cash generated from operations (doing business). In the end, if a company is not generating cash from doing business, it is not actually making money. Accrual earnings reported on the Income Statement are not sufficient alone to explain what a company is actually producing in cash. Always review “earnings” from the Income Statement in combination with a review of cash flow from operations.
Have a great weekend.
Paul, Thank you for your continued sharing of accounting, investment and spiritual wisdom. Have you thought any more about writing another book?
Hey David. I appreciate your comment. I have thought much about writing another book. In fact, there are several developed ideas. Whether I follow through, I’m not sure yet. It is quite a commitment. Again, your comment is sincerely appreciated.
Paul,
As long as you are considering writing another book, please let me offer a suggestion. What about discussing ways to reconstitute the financial statements and discuss economic profit? Professor Stephen Penman’s books were helpful in understanding the importance of separating operating assets and operating liabilities from financial assets and financial liabilities, and focusing on net operating profit after tax and calculating the return on net operating assets. In addition, he points out the need to assign a cost of capital and see how much income remains net of all expenses and a charge for the cost of capital.
Another topic might be ways to calculate the expected growth of income, cash from operations and free cash flow. As my favorite philosopher, Yogi Berra, said, “its hard to make predictions, especially about the future”.
Your book on analyzing the balance sheet and a practical application to investing is the best of its type and I would love to see you tackle another topic.
David
Thanks for the good suggestions, David. Thanks for the comment about my book too. So many things are politicized and I believe there has been widespread politicization of generally accepted accounting principles (GAAP) over the years. Financial accounting rules are set in a realm where the followers of the rules, namely corporate management, have too much input into the rules, in my view. That is, the rule-setting environment is not independent of corporate management and it should be. GAAP is not for those following the rules (corporate management) but for the investment and lending community who depend on the reliability and validity (and usefulness) of the financial reports to make their financial decisions; to properly assess risk vs. return. I believe this politicization of GAAP is at the heart of why we are trying to find better ways to parse the financial statements in order to make financial decisions.