Statement of Cash Flows

It's time to get back to the basics once again, this time casting our eyes toward the statement of cash flows. The income statement usually gets all the pub, followed closely by the balance sheet, but it's the statement of cash flows that is perhaps the most significant of the financial reports.

While the balance sheet tells us the financial condition of a company as of one particular date (sort of a snapshot in time), the statement of cash flows fills in the gap between two sequential balance sheet dates. It describes the changes that occur on the balance sheet from one period to the next and their effects on cash. It shows what changes occurred in assets, liabilities, and owner's equity and whether those changes provided or used cash. The cash flow statement also shows us how cash makes its way from the income statement to the balance sheet. Because of accrual accounting, it's not as straight a path as one might imagine.

The statement of cash flows contains three events: operating activities, investing activities, and financing activities.

Operating activities include all changes in the balance sheet as they pertain to day-to-day business operations. This section will generally have three items: net earnings, adjustments to net income that neither produce nor consume cash, and changes in operating assets and liabilities. We've been discussing Yahoo! (Nasdaq: YHOO) a bit on the discussion boards, so we'll use an example of its most recent flows from operating activities:

Three Months Ended March 31                     2000    1999
(All numbers in thousands)

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income                                   $77,851  $1,796
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization                 14,204   9,773
Tax benefits from stock options               48,321  10,467
Minority interests in operations
 of consolidated subsidiaries                  1,837     325
Non-cash gain from exchange of investments   (40,656)    ---
Purchased in-process R&D                         ---   9,775
Other non-cash charges                           717     671
Changes in assets and liabilities:
Accounts receivable, net                      (5,293) (6,170)
Prepaid expenses and other assets             (6,353) (3,519)
Accounts payable                               1,066   1,028
Accrued expenses and other current liab.      16,288   3,505
Deferred revenue                              24,191   7,177
                                             ------- -------
 Net cash provided by operating activities   132,173  34,828

The first line of the cash flow statement will always be net income (or loss). From there, the first adjustments are in the form of depreciation and amortization. These figures are added back to net income because they are expenses that do not involve expenditure of cash.

Changes in operating assets and liabilities include non-cash current assets and current liabilities. Increases in accounts receivables or inventories are deducted from net income because the company has cash dedicated to these assets.

What we're left with is the operating cash flow. This is the company's true cash profit.

The next section is investing activities. Again, we'll use Yahoo!'s most recent numbers:

Three Months Ended March 31                    2000     1999

CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment       (14,328) (11,608)
Purchases of marketable securities         (327,338)(221,140)
Proceeds from sales and maturities
 of marketable securities                   184,525  203,632
Cash acquired in acquisition                  1,557       --
                                           --------  -------
 Net cash used in investing activities    (155,584)  (29,116)

Investing activities include purchases and sales of property, plant, and equipment (PP&G), any merger and acquisition activity, and purchases of or sales from marketable securities. Investing activities are aimed at generating or freeing cash to expand and grow a business.

Finally, we have the financing activities. Looking yet again at Yahoo!'s numbers:

Three Months Ended March 31                    2000     1999

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of Common Stock, net 126,646   27,910
                                            -------   ------
Net cash provided by financing activities   126,646   27,910

Financing activities are dividend payments, stock issuance and repurchases, and the issuance, repayment, and retirement of debt. Only issuance of common stock occurred in the example above.

To wrap it all up, the final portion of the cash flow statement sums up the cash flows from the three subsections:

Three Months Ended March 31                   2000      1999

Effect of exchange rate changes on cash
 and cash equivalents                         (552)      (41)
                                            -------   ------
Net change in cash and cash equivalents    102,683    33,581
Cash and cash equivalents
 at beginning of period                    233,951   230,961
                                           -------   -------
Cash and cash equiv. at end of period     $336,634  $264,542

This final section bridges the cash balance from one period to the next. At the end of the quarter, Yahoo! had $336,634,000 in cash and this will be the number that you find listed on the balance sheet.

We'll stop here tonight, assured that you'll enjoy a peaceful early evening nap. Next week, we'll discuss how we can use some of this information.

Drip on, Fools!