As an expert in financial statements, Adam Greene knows that cash flow is one of the most important concepts business owners should understand. It gives a real picture of how a company’s finances are doing and gives pertinent insight into the health of any entity. In order to understand your business’ cash flow statement, you need to keep in mind the three main categories that compose it: cash from operating activities, cash from investing activities and cash from financing activities. Each type of cash flow metrics will let you do a cash flow analysis that in the end will allow you to foresee and compare investment opportunities.
What is Cash Flow Analysis and why is it important?
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Cash flow analysis is the inspection of an entity’s cash inflows (cash that was produced by the company) and outflows (cash that was dispersed by the company). A business’ cash flow statement provides a bond between the income statement and the balance sheet, allowing analysts to define where the company’s cash was indeed produced and dispersed during a specific period of time -usually a year.
Companies need to know their cash flow calculations because it provides significant financial information on profitability, quality of earnings, liquidity, risks, capital requirements, future growth, dividends, among other financial concepts. Cash flow statement analysis is a valuable tool that helps companies to oversee investment opportunities. Cash flow metrics can be extremely important for analysis with enterprise value, or various other measurements.
Analysts must check the statement of cash flow reports to understand the impact of a firm's operating, investing and financial activities on cash flow over an accounting period. Usually, cash flow statements show information related to the aspects listed below:
● How the company obtains and spends cash.
● Why there may be differences between net income and cash flows.
● If the company generates enough cash from operation to sustain the business and pay off existing debts as they mature
● If the company has enough cash to take advantage of new investment opportunities
What composes a Cash Flow statement?
As it was mentioned before, a regular cash flow statement is segregated into three sections: Operating activities, investing activities and financing activities.
1. Cash Flow From Operations (CFO)
Cash Flow from Operations measures the cash generated from the core business or operations of the business. These operating activities include any receipt from sales, interest, income tax and vendor payments; salary and wage payments to employees, rent payments or any other type of operating expenses should be included in this category. If you company has a trading portfolio the CFO report should include receipts from the sale of loans, debt or equity instruments.
A CFO report generally includes:
- Inflows: Revenue from the sale of goods and services, interest from debt instruments of other entities and dividends from equities of other entities.
- Outflows: Payments to suppliers, employees, government, lenders and other expenses.
2. Cash Flow from Investing Activities (CFI)
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Cash flow from investing activities will be negative most times. For most companies, it represents an investment in itself since it includes any sources and uses of cash from a company's investments, such as a purchase or sale of an asset, loans made to vendors or received from customers or any payments related to a merger or acquisition.
The CFI statement accounts the purchases and sales of long-term investments -including things such as capital expenditures, acquisitions, or investments in other securities such as stock and bonds.
A CFI report usually includes:
- Inflows: Sale of property, plant, equipment, debt or equity securities and collection of principal on loans to other entities.
- Outflow: Purchase of property, plant, equipment and debt or equity securities and lending money to other entities.
3. Cash Flow from Financing Activities (CFF)
Cash flow from Financing is in charge of measuring the activities that fund the company and stakeholders (debt and equity holders). These activities include the sources of cash from investors or banks, as well as the uses of cash paid to shareholders, also, issuing or buying back stock, issuing or repurchasing debt, and paying dividends to shareholders.
A CFI report generally includes:
- Inflows: Sale of equity securities and issuance of debt securities.
- Outflows: Dividends to shareholders, redemption of long-term debt and capital stock.
The sum of the three makes up the Total Cash Flow for the entity, which is the number analysts find at the bottom of the Cash Flow Statement and use to understand how an entity’s cash balance is doing at the beginning and ending of the time period and whether or not a company is ready to make an investment.
If you want to read more about the main categories that compose a cash flow statement, you can click here.