Interpreting company reports and accounts

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7. What to look for in the cash flow statement

Profit is a matter of opinion. Cash is a matter of fact.

The cash flow statement provides facts on whether a company has generated or consumed cash in the year, and how. It can be used in conjunction with the P&L to assess the trading results, or it can be used in conjunction with the balance sheet to assess liquidity, solvency and financial flexibility.

What can you, as an ordinary investor with no particular skill or hankering for complex accounting rules, do with a cash flow statement?

• Check whether the trend in cash flow matches the trend in profits?
  If the P&L says that profits are going up, but the cash flow statement shows a net cash outflow, an explanation is needed. There may be a good one, there may not. One explanation might be that the company has 'bought' market share by offering its customers extended credit.
• If there has been a net cash outflow in the year, was it steady or was it accelerating or decelerating towards the end of the year?
  In other words, what was the trend?. Some companies provide cash flow projections, but the ones that do are not usually the ones with a problem. Look at a share price chart to see what the market has been thinking.
• Check to see if the cash outflows for one-off costs such as reorganisations match earlier provisions against these costs.
  If the cash outflows are lower than the provisions, watch out for further cash outflows in the coming period.
• Are there large items for interest receivable as well as interest payable?
  If so, the company probably has an active cash management programme, which is good if it knows what it is doing, not so good if it doesn't. Check the accounts to see if they explain the company's cash management policy. If they do, do you understand it?

Do not be alarmed if all this seems rather difficult to you.

Cash flow analysis has been described by one investment analyst as 'Almost as specialised as heart surgery'.

It is important that you appreciate the importance of cash analysis, but you don't need to be a guru. If you check whether 'Net cash inflow from operating activities' has gone up or down, you will have done more than 90% of other private investors.

1. The five main components of a set of report and accounts 2. What to look for in the directors' report 3. What to look for in the P&L 4. Earnings per share (EPS) 5. Price earnings ratio (P/E) 6. What to look for in the balance sheet 7. What to look for in the cash flow statement 8. What to look for in the auditors' report 9. Other information sources 10. Conclusion