Businesses and investors depend on financial statements to accurately depict the financial condition of an organization. Financial statements are vital to making investment decisions. Two important financial statements readily used by investors include the cash flow statement and statement of shareholders’ equity. The cash flow statement shows the cash that is coming into and leaving a company, while the statement of shareholders’ equity shows detailed changes in the shareholders’ equity listed on a company’s balance sheet. To make informed investment decisions, investors should understand the components of the cash flow statement and statement of shareholders’ equity.
Cash Flow Statement Components
The cash flow statement includes three main components: operating, investing and financing activities. Operating activities measures the cash inflows and outflows in reference to a company’s core business operations. Important categories under operating activities include the cash associated with accounts receivable, accounts payable and inventory. Investing activities typically shows cash leaving the company to purchase long-term investments, such as equipment or buildings. Investing activities can also show cash a company receives from selling some of its investments. The third component shows the cash flow from financing activities, which may include cash a company raised from selling stocks and bonds to investors or money borrowed from a bank. The cash a company spends to repay a loan also appears under financing activities.
Importance of the Cash Flow Statement
The cash flow statement is important to investors because it shows whether a company has sufficient cash on hand, even while it’s profitable. Companies need adequate cash flow to maintain business operations and make necessary business investments to spur growth. Many investors compare the cash flow statement to the income statement to determine if the cash the company receives from operating activities is exceeding net income. Some investors are wary of companies with cash that is significantly less than net income.
Understanding the Statement of Shareholders’ Equity
The elements of the statement of shareholders’ equity include preferred stock, common stock, treasury stock, unrealized gains and loss, retained earnings and dividends. Preferred stock gives shareholders the right to receive dividends before common stockholders. Common stock allows shareholders to receive as large of a dividend as a company decides to issue. If a company chooses to pay out a small dividend, common shareholders may not receive dividends if the company pays all of the money out to preferred shareholders. Treasury stock includes shares that the company repurchased from the open market. Unrealized gains and losses reflect the price changes in a company’s investments that are available-for-sale. Retained earnings refers to the part of a company’s profit it chooses to keep instead of pay as distributions to shareholders. Dividends include the portion of net income a company pays to shareholders as an incentive for investing.
Importance of the Statement of Shareholders’ Equity
The statement of shareholders’ equity is important to investors because it shows a company’s equity interest among shareholders. Investors subtract liabilities from the amount of a company’s total equity to determine its net worth. Retained earnings is a component of the statement of shareholders’ equity that investors closely analyze because it shows the amount of money a company is reinvesting in itself to further growth.