What You Should Know about Cash Flow Statements for Trading - dummies

What You Should Know about Cash Flow Statements for Trading

By Michael Griffis, Lita Epstein

When traders review income statements, they’re looking at information based on accrual accounting. In accrual accounting, sales can be included when they’re first contracted, even before revenue from them is collected. Sales made on credit are shown even if the company still needs to collect from the customer.

Expenses are recorded as they’re incurred and not necessarily as they’re paid. However, the income statement definitely does not show a company’s cash position. A company that’s booking a high level of sales can have a stellar income statement but nevertheless be having trouble collecting from its customers, which may put that company in a cash-poor situation. That’s why cash-flow statements are so important.

You can get an idea of your favorite company’s actual cash flows from the adjustments shown on its cash-flow statement.

Operating activities

Looking at cash flow from operating activities gives you a good picture of the cash that’s available from a company’s core business operations, including net income, depreciation and amortization, changes in accounts receivable, changes in inventory, and changes in other current liabilities and current assets.

Calculating cash flow from operating activities includes adjustments to net income made by adding back items that were not actually cash expenditures but rather were required for reporting purposes. Depreciation is one such item. Similarly, expenses or income items that were reported for accrual purposes are subtracted out.

This section of a company’s cash-flow statement shows actual net cash from operations. You can see three successive years of cash flow from operating activities at Home Depot and Lowe’s.

Fiscal Year 2012 2011 2010
Home Depot 6,651,000 4,585,000 5,125,000
Lowe’s 4,349,000 3,852,000 4,054,000

All numbers are in thousands.

You can see that both Lowe’s and Home Depot’s cash position improved significantly from 2011 to 2012. You can see that the improving economic picture is helping both companies improve their cash flow. But neither company is back to its high in 2007 before the downturn. In 2007, Home Depot’s cash flow from operating activities was $7,661,000 and Lowe’s was 4,502,000.


For all companies, one of the largest adjustments to cash flow is depreciation. Depreciation reflects the dollar value placed on the annual use of an asset. For example, if a company’s truck will be a useable asset for five years, then the cost of that truck is depreciated over that five-year period.

For accounting purposes, a company must use a method called straight-line depreciation, a method of calculating depreciation in which the company determines the actual useful life span of an asset and divides the purchase price of that asset by that life span. Each year depreciation expenses are recorded for each asset. Although no cash is paid out, the total amount of depreciation is added to the cash-flow statement.

For tax purposes, companies can be more creative by writing off assets much more quickly and thus reducing their tax burdens at the same pace. One type of write-off — dealing with Section 179 of the Internal Revenue Code — enables a company to deduct the full cost of an asset during its first year of use.

Other methods enable a company to depreciate assets sooner than the straight-line method, but not as soon as the 100 percent permitted by Section 179. How a company depreciates its assets can have a major impact on how much that company pays in taxes.

Although you won’t know how a company depreciated its assets by looking at its cash-flow statement, you will know the adjustment made for depreciation for cash purposes.

Financing activities

The financing activities section of a cash-flow statement shows any common stock that was issued or repurchased during the period the report reflects, and any new loan activity. The financial activities section gives you a good idea whether the company is having trouble meeting its daily operating needs, and as a result, is seeking outside cash.

You won’t, however, find that new financing always is bad. A company may be in the process of a major growth initiative and may be financing that growth by issuing new debt or common stock.

The bottom line: This section of the cash-flow statement shows a company’s total cash flow from financing activities. You can see three successive years of cash flow totals from financing activities at Home Depot and Lowe’s.

Fiscal Year 2012 2011 2010
Home Depot (4,048,000) (4,451,000) (3,503,000)
Lowe’s (2,549,000) (1,651,000) (1,801,000)

All numbers are in thousands.

A negative cash flow from financing activities usually means that a company has either paid off debt or repurchased stock. In this case both Home Depot and Lowe’s repurchased stock in 2012. A positive cash flow here usually means new stock or debt was issued. Both companies issued new debt during this period as well.

Obviously, many combinations of various financing activities can affect the bottom line, but the key for traders is to gain an understanding of why the change occurred and whether the company’s reason for making the change was solid enough to improve its profit and growth picture.

Investment activity

This section of the cash-flow statement shows you how a company spends its money for growing long-term assets, such as new buildings or other new acquisitions, including major purchases of property, equipment, and other companies. It also shows you a company’s sales of major assets or equity investments in other companies. Tracking investment activities gives investors a good idea of what major long-term capital planning activities have taken place.

This section shows a company’s total cash flow from investing activities. Comparing three successive years of investment activities by Home Depot and Lowe’s, both companies had significant capital outlays that more than likely were for opening new stores in 2012 and 2011.

Fiscal Year 2012 2011 2010
Home Depot (1,129,000) (1,012,000) (755,000)
Lowe’s (1,437,000) (2,184,000) (1,886,000)

All numbers are in thousands.