After the income statement, Twaddell says many equity investors check the cash-flow statement to see what's really happening in the business. It's this statement that makes adjustments for all noncash transactions to show just how much cash is used or thrown off by a company. Items such as depreciation-an expense that cuts into earnings but doesn't eat into cash-are added to cash flow. Accounts receivable, which get booked as revenue but don't provide real cash, are taken out of the cash-flow calculation.
Need more explaining? Read Cash Flow Analysis to have the fog lifted.
There are myriad inferences investors can draw from cash-flow statements, says Twaddell. But ultimately, they're looking at the capital intensity of the business: "how many dollars have to go in on the front end before one pops back out on the back end," he says. Seasonality (which requires companies to spend even when revenue is not being generated), lengthy collection periods and growing accounts receivable require capital. So the question in investors' minds becomes, How much capital will this business require, and is there a plan in place to fund its growth?
Investors Capital scored well here, says Twaddell. The company's receivables, mostly commissions from insurance companies, were paid in 30 days or less. There was no cyclicality in the revenue stream to speak of, and cash-flow statements showed the company was almost entirely self-funding. "As a result," says Twaddell, "the capital raised in the IPO wouldn't be used to fund operations but expansion and, presumably, increased earnings-raison d'�tre for most equity investors."