Harvard Business School

9-193-103

os t Rev. November 3, 1998

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Statements of Cash Flows: Three Examples

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John Stacey, a sales engineer for Aldhus Corporation, was worried. A flight delay had caused him to miss last week’s accounting class in the evening MBA program in which he had enrolled at the suggestion of the personnel director at Aldhus, a growing manufacturer of computer peripherals. The class he had missed had been devoted to a lecture and discussion of the statement of cash flows, and he was sure the material he had missed would be covered in the weekly quiz that was part of each class session. A classmate had faxed Stacey some notes distributed by their instructor, but they were too cryptic to be
company like Exxon.
John Stacey: That is interesting! How can I use each section of the statement?

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Lucille Barnes: The operating activity section is the cash-flow engine of the company. When this engine is working effectively, it provides the cash flows to cover the cash needs of operations. In a healthy, growing company, we would expect growth in operating working capital accounts such as inventory and accounts receivable (uses of cash) as well as in accounts payable and other operating payables (sources of cash). Obviously there can be quite a bit of variability in working capital accounts from period to period, but on average inventories, receivables, and accounts payable usually grow in growing companies. In addition, this operating cash-flow engine provides cash for needed investments, to repay debt, and to pay dividends. There are exceptions, of course. Start-up companies, for example, usually have negative cash flows from operations because they have not gotten their cash-flow engines up to speed. Companies in cyclical industries may have negative operating cash flow in a “down” year; a company that has experienced an extensive strike could also be expected to have negative cash flow from operations. Although an occasional year of negative operating cash flow does not spell disaster, nonetheless, we should expect operating cash flow, on average, to be positive.
Investing activities are a different story. Whereas we expect positive operating