Financial Statement and Cash Flow Analysis
It is often said that accounting is the language of business. Corporate finance relies
heavily on accounting concepts and language, but the primary focus of finance
professionals and accountants differs significantly. Accountants apply generally accepted
accounting principles (GAAP) to construct financial statements that attempt
to portray fairly how a company has performed in the past. Accountants generally
construct these statements using an accrual-based approach, which means that accountants
record revenues at the point of sale and costs when they are incurred, not
necessarily when a firm receives or pays out cash. In contrast, financial professionals
use a cash flow approach that focuses their attention to a greater degree on current
and prospective inflows and outflows of cash. This chapter describes how financial
professionals use accounting information and terminology to analyze the firm’s cash
flows and financial performance. We begin with a brief review of the four major fi-
nancial statements. Next, we use these statements to demonstrate some of the key
concepts involved in cash flow analysis. We
give special emphasis to the effect of depreciation
and other noncash charges on cash
flows and the various inflows and outflows
of cash to the firm. Finally, we discuss the
use of some popular financial ratios to analyze
the firm’s financial performance.