What to Look for When Reading a Cash Flow Statement

Introduction

A cash flow statement is a financial report that summarizes the inflows and outflows of money over a given period of time, typically a month, quarter, or year. It is used by businesses to make decisions regarding issues such as cash reserves and bank account management. Identifying cash flow is crucial in order to maintain healthy business operations and ensure that debts are paid on time.

When reading a cash flow statement, it's important to understand the different elements of the document and how to interpret them accurately. This article will discuss what to look for when reading a cash flow statement.

Three Types of Cash Flows

A cash flow statement is an important document used to track a company's cash inflows and outflows. It is important to understand these cash flows to assess a company's liquidity, solvency and overall profitability. There are three main types of cash flows: operating cash flows, investing cash flows and financing cash flows.

Operating Cash Flows

Operating cash flows are cash inflows and outflows related to day-to-day activities of a company's operations. Examples of operating cash flows include cash received from selling goods or services, cash paid for inventory, salary payments, tax payments and other general operating expenses.

Investing Cash Flows

Investing cash flows are cash inflows and outflows related to the purchase or sale of long-term assets. Examples of investing cash flows include cash paid for plant and machinery, cash received from selling investments or property, cash spent on acquisition of businesses and other fixed assets.

Financing Cash Flows

Financing cash flows are cash inflows and outflows related to the activities of financing a company, such as issuing or repaying debt or equity capital. Examples of financing cash flows include cash received from issuing shares, cash paid for issuing debt, and cash received from shareholders or other investing parties such as venture capitalists.

How to Analyze Operating Cash Flows

When reading a cash flow statement, analysis of the operating cash flows is an important part of assessing the company's financial condition. Operating cash flows are those that arise from a company's normal course of business, such as from sales, debt issuance, and interest income. The following steps can help in reading and analyzing operating cash flows.

Begin with Cash Receipts

Usually, cash receipts occur from activities related to sales and collection of accounts receivables. For example, the cash flow statement would reflect money coming in from customers who have purchased the company's products or services. Analyzing cash receipts can help in understanding the company's performance and its ability to generate revenue.

Analyze Cash Disbursements

Cash disbursements from operating activities can include payments to vendors, employee wages and salaries, rent, and debt payments. These disbursements can provide a snapshot of the company's expenses and the succession of capital necessary to keep the business running. Analyzing both the influx and outflow of cash gives insight into the company's effectiveness in sourcing and managing its resources.

Compare to Previous Years

Comparing the current period to past periods can also be helpful in understanding the company's financial condition. Trends in cash flows can help a financial analyst assess the company's stability, liquidity, and overall performance. Some key metrics that can be used are net cash flow and free cash flow, which can indicate whether the company is increasing or decreasing its liquidity.

• Net Cash Flow is calculated by subtracting cash paid from cash received.
• Free Cash Flow is calculated by subtracting cash paid out for capital investments from net cash flow.

A careful analysis of a company's operating cash flows will enable a financial analyst to assess the financial strength and stability of the company and make an informed decision about investing. Analyzing cash flow statements will give insight into the company’s ability to pay off its debts, pay out dividends, invest in new projects, and generate income.

Analyzing Investing Cash Flows

When reading a cash flow statement, the investing activities section should be closely examined to assess the performance of the company’s investments. Specifically, investors should look to identify cash generated or used in purchases of investments and disposals of investments. Further, analyzing investing activities over multiple years is useful in understanding trends in investment activity.

Identify Purchases of Investments

The first step in assessing investing cash flows is to identify all purchases of investments made by the company. These investments may be classified as short-term or long-term, depending on the length of the holding period, and the amount invested should be specified in the cash flow statement. Generally, larger investments will have a significant impact on the company’s financial position and performance.

Look for Disposals of Investments

Another important consideration when analyzing investing activities are disposals of investments. Disposals refer to when the company sells its investments, and the proceeds from these sales should show up in the net cash flows in the investing activities section. Disposals may be intentional (e.g. when a company plans to reinvest the proceeds) or unintentional (e.g. when an investment’s value sharply declines).

Compare to Previous Years

Finally, comparing the investing activities to previous years may reveal trends that can provide useful information. This is best done by creating a timeline of the major investments and disposals, and looking for patterns. Additionally, comparing the magnitude of the investing activities to that of other companies in the same industry can provide further context to the performance of the company’s investments.

• Identify purchases of investments.
• Look for disposals of investments.
• Compare investing activities to previous years.

Analyzing Financing Cash Flows

Cash flow statements are an important part of any business's performance report, and can provide insights into potential areas of improvement and where resources can be reinvested. To gain an understanding of the company's financial performance, it is important to analyze the financing activities of the cash flow statement. Here are a few tips for what to look for when considering financing cash flows.

Look for Any Borrowing Activity

The first thing to look for when analyzing financing cash flows is any activity that involves the business taking on debt or borrowing money. Because interest payments on debt will typically be a fixed expense, it is important to identify any changes in debt levels, as this could potentially impact the company's ability to generate a profit.

Determine Repayment of Borrowings

Once you have identified any borrowing activity, it is important to determine how much of the debt has been repaid. Ideally, the company should be regularly paying off its debt, as this will reduce the level of interest expenses and free up additional funds that can be reinvested in the business.

Compare to Previous Years

The best way to evaluate the cash flow statement is to compare the financing activity to previous years. This will allow you to see if there has been any significant change in the levels of borrowing, and whether there have been any changes in the amount being repaid. This can be a useful indicator of whether the company's financial position is improving or deteriorating.

• Look for any borrowing activity
• Determine repayment of borrowings
• Compare to previous years

Review and Reconcile

The ultimate objective of reading and evaluating a cash flow statement is to ensure that transactions have been accurately reported and that the cash flow reported matches the company’s net income for the accounting period.

Ensure Cash Flow Matches Net Income

The cash flow statement should list total cash inflows and outflows from operating activities, investing activities, and financing activities. By summing these three sections, you can quickly arrive at the net cash flow for the period. This number should match the company’s net income for the same period on the income statement.

It is also important to compare changes from the prior period. How has cash flow changed between the current period and the previous one? Why have they changed? This analysis can reveal not only the usability of cash to shareholders, but can also point to larger changes in a company’s operations.

Balance Sheet Accounts Match

Also a good idea to review the balance sheets of both the current and prior period. Non-cash items such as depreciation and amortization that are recorded in the income statement may not show up in the cash flow statement. They should be reviewed to ensure that the balances match the cash flows.

In addition, cash and cash equivalents must be accurately reported and reconciled with the balance sheet to come up with the net cash flow. Equity accounts should also be revisited to detect any irregularities in the cash flows.

Conclusion

Reading a cash flow statement can be intimidating and complex, but with a bit of research and practice, it can be made comprehensible. In this blog post, we discussed seven important points to consider when analyzing a cash flow statement: 1) Analyze Net Cash Flow; 2) Understand Cash Flow Impact of Non-Cash Items; 3) Check the Cash Flow Statement for Accuracy; 4) Analyze Changes in Investing; 5) Understand Operating Cash Flow; 6) Analyze Changes in Financing; and 7) Assess Seasonal Trends. To sum up, time and effort put into understanding a cash flow statement can produce invaluable insights on a company's financial health over a period of time.

Recap of Important Analysis Areas

To get the most out of a cash flow statement review it is important to focus on:

• Analyzing the net cash flow
• Understanding non-cash items impacting cash flow
• Checking the statement for accuracy
• Analyzing changes in investing
• Understanding the components of operating cash flow
• Analyzing Financing changes
• Recognizing Seasonal Trends

Next Steps in Cash Flow Analysis

In addition to understanding the components of the cash flow statement, there are numerous methods investors can use to analyze the data contained in the statement. Some methods may include: cash flow forecasting, trend assessment, liquidity ratios, and growth rates. Conducting further analysis of the cash flow statement over time can provide further insights into the financial stability of a company. Ultimately, the goal is to assess risk, make sound investments, and protect against loss.