Wondering what the cash flow statement definition is?
By definition, a cash flow statement is a financial statement that depicts the inflows and outflows of cash for a particular period. It provides information about a company's sources and uses of cash, including operating activities (such as revenue and expenses), investing activities (such as buying or selling assets), and financing activities (such as issuing or repurchasing stock or borrowing money).
In any business, a cash flow statement shows the inflow and outflow of cash within an organisation during a particular period, typically a fiscal quarter or year. Analysing cash flow statements help understand how much cash is being generated, where it comes from, and how it is used.
The cash flow statement helps to assess a company's liquidity, solvency, and overall financial health by showing how much cash is generated or used by its various activities. It is an important tool for investors, analysts, and managers to evaluate a company's financial performance and make informed decisions.
How to know if a cash flow statement is good or bad?
A good cash flow statement demonstrates positive cash flow and positive operating cash flow, in addition to rational investing and financing activities.
Positive cash flow implies that the company earned more money than it spent, while positive operating cash flow indicates that the company's core operations generate money, and prudent investing and financing activities indicate that the company is investing and financing sensibly.
A bad cash flow statement, on the other hand, shows negative cash flow, negative operating cash flow, and reckless investing and financing operations, which can suggest possible concerns with a company's financial health.
It is also important to evaluate the cash flow statement in the context of other financial statements and business factors to get a holistic view of a company's financial health.
The purpose of the statement of cash flows
Liquidity management: Helps companies manage their liquidity by monitoring their cash inflows and outflows. It helps them ensure they have enough cash to fulfil their financial obligations, such as paying suppliers, employees, and lenders.
Financial planning: Helps companies plan their finances effectively. It provides insights into their cash position, enabling them to make informed decisions on investments, expansions, and other financial activities.
Debt management: Helps companies manage their debt by assessing their ability to repay their loans. It provides insights into their ability to generate cash and meet their debt obligations, enabling them to make informed decisions on borrowing and repayment.
Investment decisions: Helps companies make informed decisions on investments. It enables them to assess the potential return on investment and the risk involved, helping them make better investment decisions.
Financial reporting: Essential for financial reporting and provides valuable information on a company's financial performance and liquidity.
What to look for when analysing cash flow statement?
Operating cash flow
The cash generated or used in a business's day-to-day operations. It includes cash inflows from sales revenue and outflows from expenses, such as salaries, rent, bonus payments to contractors and other utilities.
Investing cash flow
This is the cash used for investments, or investing activities such as buying or selling property, plant, and equipment, and investments in other companies.
Financing cash flow
The cash used for financing activities, such as borrowing or repaying loans, issuing or buying back stocks, and paying dividends.
Net cash flow
It is the difference between the cash inflows & outflows over a specific period. A positive net cash flow indicates more cash coming in than going out, while a negative net cash flow suggests more cash going out than coming in.
Changes in cash balance
It reflects the difference between the beginning and ending cash balance over a specific period. It shows the amount of cash generated or used during that period.
How to perform cash flow analysis?
Step 1: Look at the overall net cash flow - Determine the net cash flow for the period (a month, quarter, or year). If it is positive, the company has generated profit (more cash than it used}during the period, and if it is negative, it has used more cash than generated.
Step 2: Analysing cash flows from operating activities - Look for trends and changes in net income, depreciation, and working capital (such as accounts receivable and accounts payable).
Step 3: Analysing cash flows from investing activities - Look for trends and changes in the company's investments in assets such as property, plant, and equipment and the purchase/sale of assets/investments to determine the company's investment activities.
Step 4: Analysing cash flows from financing activities - Look for trends and changes in the company's financing activities, such as issuing bonds or stock, repaying debt, and paying taxes and dividends, to determine the company's financing activities.
Step 5: Calculate free cash flow - Subtract capital expenditures from cash from operating activities to determine the company's free cash flow.
Step 6: Compare to other financial statements - Comparing the cash flow statement to the income statement and balance sheet helps better understand the company's financial health and performance.
Step 7: Interpret cash flow statements for red flags - Look for unusual items or trends that may be strong indicators of financial trouble, such as a significant negative net cash flow or consistently negative free cash flow.
How to analyse a cash flow statement using ratios?
|- Operating cash flow
Net income + Non-cash expenses - Changes in working capital
- Free cash flow
Operating cash flow - Capital expenditures
- Cash conversion cycle (CCC)
Days inventory outstanding + Days sales outstanding - Days payables outstanding
- Cash flow margin
Operating cash flow / Total revenue
- Operating cash flow ratio
Operating cash flow / Current liabilities
- Price-to-cash-flow ratio
Stock price / Operating cash flow per share
Cash flow analysis: Example
Following is a cash flow analysis example:
|Amount (in €)|
|Cash flows from operating activities|
|Net income||75 000|
|Depreciation and amortization||20 000|
|Increase in accounts receivable||(15 000)|
|Increase in accounts payable||10 000|
|Cash provided by operating activities||90 000|
|Cash flows from investing activities|
|Purchase of property, plant, and equipment||(50 000)|
|Sale of investments||15 000|
|Cash used in investing activities||(35 000)|
|Cash flows from financing activities|
|Issuance of bonds||100 000|
|Repayment of bank loan||(25 000)|
|Dividends paid||(20 000)|
|Cash provided by financing activities||55 000|
|Net increase in cash and cash equivalents||110 000|
|Beginning cash and cash equivalents||70 000|
|Ending cash and cash equivalents||180 000|
What does a cash flow statement show?
An analysis of the sections of cash flow statement above gives us the following:
- Operating cash flow = €90,000
- Investing cash flow = (€35,000)
- Financing cash flow = €55,000
- Net cash flow = €110,000
- Changes in cash balance = €180,000
Vertical analysis of a cash flow statement
Vertical analysis is a financial analysis technique that compares each line item on a financial statement to a base amount to determine the proportion of the total.
The base amount for a cash flow statement is typically the net cash flow from operating activities.
To perform a vertical analysis of a cash flow statement:
- Determine the base amount
- Calculate the percentage of each line item
- Analyse the results
|Amount (in €)||% of Net Operating Cash Flow|
|Cash flows from operating activities||100%|
|Net income||75 000||83,33%|
|Depreciation and amortization||20 000||22,22%|
|Increase in accounts receivable||(15 000)||-16,67%|
|Increase in accounts payable||10 000||11,11%|
|Cash provided by operating activities||90 000||100%|
|Cash flows from investing activities|
|Purchase of property, plant and equipment||(50 000)||-55,56%|
|Sale of investments||15 000||16,67%|
|Cash used in investing activities||(35 000)||-38,89%|
|Cash flows from financing activities|
|Issuance of bonds||100 000||111,11%|
|Repayment of bank loan||(25 000)||-27,78%|
|Dividends paid||(20 000)||-22,22%|
|Cash provided by financing activities||55 000||61,11%|
|Net increase in cash and cash equivalents||110 000||122,22%|
|Beginning cash and cash equivalents||70 000||77,78%|
|Ending cash and cash equivalents||180 000||200%|
(N.B: The vertical analysis helps identify areas where the company generates or uses cash.)
Is it necessary to always have positive cash flow?
A company is not required to have a constant positive cash flow. In fact, a few companies may experience negative cash flow throughout some periods despite maintaining solid financial health.
When a company invests in new projects or assets, pays off debt, or returns capital to shareholders through dividends or stock buybacks, negative cash flow can occur. However, if a company consistently has negative cash flow over an extended period of time, it may indicate potential financial problems.
For example, a long period of negative operating cash flow may suggest that the company's core operations are not generating enough cash to support the business. Negative investing cash flow for an extended period may suggest that the company is not making sound investment decisions.
Negative financing cash flow for an extended period may indicate that the company is struggling to raise capital or pay off debt.
Check out our video for more information on cash flow management:
What does the cash flow statement tell an analyst?
The cash flow statement informs financial analysts about a company's cash inflows and outflows during a specific time. It depicts cash sources and uses, such as operating, investing, and financing activities. The cash flow statement can be used by analysts to assess a company's liquidity, solvency, and overall financial health.
Analysts can precisely examine a company's ability to earn cash from core operations, invest in future growth, and pay financial obligations. The cash flow statement can also highlight potential red flags such as negative cash flows, a high degree of investment or financing activity, or significant changes in cash flow patterns.
How does a cash flow analysis help?
Cash flow analysis is a financial analysis technique used to evaluate the inflow and outflow of cash within a business. It aims to determine the company's ability to generate cash, meet its financial obligations, and fund its future growth. It can help identify potential cash flow problems, such as cash shortfalls or excessive spending, and enable business owners and investors to make informed decisions about the organisation's financial management.
- Analysis of cash flow statements can help business owners and investors understand a company's cash position and liquidity, identify potential cash flow problems, and make informed financial decisions.
- Understanding cash flow analysis is crucial for managing finances, making informed investment decisions, and ensuring financial stability.
- The bottom line is that analysing cash flow statements helps companies ensure they have enough cash to meet their expenses/ financial obligations and enables them to avoid cash problems and achieve their financial goals.
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