About a month ago, we started a series called " Learnin's From My MBA ." The series was meant to take the business concepts I had learned in my MBA program and present them to you, an audience of scientists with no business background.
The first part of that series, entitled "The Annual Report," gave a brief summary of the different sections of an annual report and what they can tell you about a company. In the last 2 weeks, we've looked at two of the three quantitative financial statements in an annual report: the Balance Sheet and the Income Statement.
This week, in the fifth part of the series, we take a quick look at the cash flow statement. If you haven't read at the very least the last two essays in this series, you should probably start at the beginning : A lot of the concepts and knowledge will be cumulative, and we'll be referring back to the Balance Sheet  and Income Statement  throughout today's analysis.
As usual, we'll be using a real-live company as an example--Alta Genetics, a small Canadian biotech firm. This series is designed for readers to "work along" with the information contained here, by downloading and following from their Annual Report .
The Income Statement
The Cash Flow Statement does exactly what the name implies: It gives a summary of the flows of cash in and out of the company. It is, like the income statement, a summary for the year, and not a snapshot like the balance sheet. Basically, any time actual hard cash entered or left the company for any reason, it gets summarized for the year in the statement of cash flow.
So you might ask, what's the difference between this and the income statement, which shows sales figures and profits for the year? Well, the main difference is that cash flow is much more limited. If you sold something, but haven't received the cash yet, it would appear on the income statement, but not on the cash flow statement. Also, "soft" expenses that aren't really paid for in cash, but give a reflection of the expensing of assets over time (like depreciation expense), show up on the income statement but don't on the statement of cash flow.
Statements of cash flow are extremely important in start-up businesses and much less important in large conglomerates like General Motors. When a business is starting up, being able to pay the employees, the people that sell you goods, or the creditors is a day-to-day concern, and a strong cash flow statement means that the company has been able to manage its growth. However, with a large company that is able to find financing at the drop of a hat, the cash flow statement often has less to do with the viability of the company and more to do with the strategy the company has chosen with respect to financing.
So, let's get to it--a line-by-line description of what the statement's all about.
The first source of cash has the heading "Operating Activities." Simply put, these are the sources of cash from the day-to-day operations of the business. This section includes all the stuff you bought and sold in the normal course of business dealings.
The first line item under the "operating activities" heading is "net loss." This is, quite simply, the "net loss" line from the income statement--the amount of money lost through the normal course of business last year. To this number, we will be adding the expenses that we subtracted on the income statement but that didn't really cost us any cold hard cash. If you're confused, don't worry--it'll become clearer after a couple of examples.
This is the "amortization" line item from the income statement--it's the "using up" of the life of equipment. Remember the example of the centrifuge with a 10-year life-span getting amortized over time? Well, this is that exact same line item again. It made sense to have "amortization expense" on the income statement, because the life of the asset was "used up" while making the stuff you were selling that year. But when we're figuring out the cash flow statement, we have to add this figure back to the net loss, because we didn't really pay for it in cash--no one was putting quarters into the centrifuge machine every time they used it. So, although it was a genuine expense, it wasn't a cash flow in or out of the firm. We therefore add it back to the net loss figure--the last figure on the income statement and the first figure of the cash flow statement.
Deferred Income Taxes
Again, though deferred income taxes (described in the "Income Statement" dissection ) were an expense accrued that year, they weren't really paid for in cash--the payment was postponed to the following year, so we add this figure back to the net loss as well.
Foreign Exchange Gain, Write-Down of Capital Assets
Both these line items are also taken right out of the income statement. Again, these are items that change the "income" of the company without affecting the company's cash position--changing the value of a capital asset or of a foreign exchange position doesn't change the real cash you have in the bank and doesn't require any flow of cash in or out of the company.
Net Increase in Noncash Working Capital Items Affecting Operations
This is kind of a "cheat." It's an adjustment for some reason that's not all that clear from its description here. It is a nontypical item that won't be seen in every annual report. We won't be explaining its meaning here, but will save that for a future article, where we explain the "notes" section of the report. Remember, any time you see any kind of sign that says something is explained in the notes section, it's usually something that can't be explained by a mere heading, or that the figure given is open to interpretation.
Cash Provided by Operating Activities
By taking net loss and adding back the noncash expenses and deductions, we find the net change in cash position due to the general day-to-day operating activities of the company.
A second important source of changes in cash flow is borrowing or paying back money. The "financing activities" section describes the changes that took place due to an increase or decrease in financing of the company.
The line items in this section are fairly self explanatory: Positive cash flow (or proceeds) from long-term, short-term, or bank debt simply means that you borrowed money that year, either long-term, short-term, or in the form of a bank loan. The other way you can "finance" a company is by issuing shares in the company--simply by printing up more shares and selling them on the stock exchange. This usually causes share prices to go down (because you are diluting the company, and each share represents ownership in a smaller fraction of the company), but it also creates an influx of cash into the company.
The third important way a company changes its cash position is through gaining or losing money through investing the cash it's got on hand. This section deals with changes in cash position due to these investments.
Acquisition of Capital Assets, Net of Government Assistance
Capital assets are things like land, or a building, or a centrifuge: They're stuff you buy once and use over many years.
Acquisition of Production Livestock
Because this company sells a replenishable item made from livestock, the livestock itself is kind of a capital asset, in that it's amortized over many years. The purchase of livestock represents an additional source of change in cash flow position that was unaccounted for in the income statement.
Increase in Development Inventory
Again, stuff you bought that wasn't expensed in the income statement. It affected your cash position, but not your income position.
Increase in Investment Tax Credits
Money from the government. "Free." Changing your company's cash position, because it's taxes you said you paid but didn't end up having to.
Acquisition of Other Assets
This line item is fairly self-explanatory--more stuff you bought with cash that wasn't expensed (or "used up") that year, and thus not taken into account in the net loss line.
Net Proceeds on Minor Dispositions of Livestock
These were positive changes in cash flow due to the sale of some of the company's livestock. The line item refers to "minor dispositions" to remind the shareholder (or whoever is reading this) that the company is healthy and isn't selling off it's assets--just a couple of minor things they didn't really need anymore.
Proceeds on Disposition of Capital Assets
Same as the dispositions in livestock, only of the other capital assets in the company--the sale of an old centrifuge, for example.
Foreign Exchange Translation
This is a change in cash position due to an exchanging, for example, of Canadian dollars into U.S. dollars. Where foreign exchange gain," in the operating activities, was just a change in what the money was worth, here this is money that was actually converted from one currency to another, with a profit or loss made on the exchange.
Repayment of Loan Receivable
More investment changes--here a loan that was lent out by the company was repaid this year. Which means a change in the cash position in the company, because the loan repayment was a bunch of cash that was taken in by the company.
The next line, "cash inflow (outflow)," adds up all the changes in cash position that took place this year, from operating activities, financing activities, and investing activities. This change in cash position is added (or subtracted) from the cash that was in the company at the beginning of the year to find the cash position of the company at the end of the year. This should correspond, theoretically, to the amount of money they have in the bank (found in the Balance Sheet), and, lo and behold, it does!
So now we've gone through a Cash Flow Statement, and you know the bare essentials of what each line basically means. Don't worry if you didn't get all of it--the cash flow statement is the hardest statement to understand.
Next week we'll be tackling the "anomalies" in the Annual Report: the notes section. These are the explanations of the line items in the other three statements--how did they determine an appropriate level of amortization? What caused some of their weird losses? And much more. So stay tuned.