Reading: The Cash Flow Statement
A solid financial plan is the basis of every valuation exercise and every significant management decision. The financial plan allows us to identify the firm's capital needs as well as its ability to generate cash. It also unveils the various sources and uses of funds. This section shows how to set up a financial plan.
1. The Cash Flow Statement
The previous section has provided us with most of the necessary accounting knowledge to determine the relevant cash flows of a firm. Remember that we ultimately want to know how much cash the firm generates with its operating activities and how much is used for its investment and financing policies. In this section we derive the framework to determine the relevant cash flows of a firm. The easiest way to do so is to go back to our example of firm X from the previous section.
Example: So far, we have studied the balance sheet and the income statement of firm X. But what do these statements actually tell us about the firm's ability to generate cash?
In general, we want to find the answers to the following questions:
- How much cash did the firm generate with its operations?
- How much cash was used for investments?
- How much cash was available for distribution to all the providers of capital?
- How much cash was distributed to the providers of debt?
- How much cash was available for distribution to the providers of equity?
- How much cash was distributed to the providers of equity?H
- How much cash remained after all stakeholders have received their compensation?
Let us go through these questions step by step.