The cash flow statement is a financial document that provides an overview of the cash inflows and outflows of a business during a specified period. It’s one of the three main financial statements, along with the income statement and balance sheet.
Most businesses focus on the profit and loss – Afterall this leads to taxes – but the cash flow is arguably more important to the success of a business.
The cash flow statement is an essential tool for assessing a company’s liquidity, solvency, and ability to generate cash. In this blog, we will take a closer look at the cash flow statement, its components, and how it can be used to evaluate a company’s financial health.
Components of the Cash Flow Statement
The cash flow statement is divided into three main sections: operating activities, investing activities, and financing activities. Let’s take a closer look at each section:
- Operating Activities
The operating activities section of the cash flow statement shows the cash inflows and outflows that result from a company’s primary business activities.
This section includes cash received from customers, cash paid to suppliers and employees, and any interest or taxes paid. The operating activities section is an essential indicator of a company’s cash-generating ability and is often the most critical section of the cash flow statement.
- Investing Activities
The investing activities section of the cash flow statement shows the cash inflows and outflows that result from a company’s investments in assets such as property, plant, and equipment, and investments in securities.
This section includes cash paid for the purchase of long-term assets and cash received from the sale of long-term assets. The investing activities section provides insights into a company’s capital expenditure and its strategy for investing in its future growth.
- Financing Activities
The financing activities section of the cash flow statement shows the cash inflows and outflows that result from a company’s financing activities, such as issuing stock, paying dividends, and issuing or repaying debt.
This section includes cash received from the issuance of stock, cash paid for dividends, and cash received from the issuance of debt. The financing activities section provides insights into a company’s financing strategy and its ability to access capital markets.
Interpreting the Cash Flow Statement
The cash flow statement is an essential tool for assessing a company’s financial health. Here are a few ways that the cash flow statement can be used to evaluate a company’s performance:
- Assessing liquidity
The cash flow statement provides insights into a company’s liquidity, or its ability to meet its short-term financial obligations. The operating activities section of the cash flow statement shows the net cash provided by operating activities, which is an indicator of a company’s cash-generating ability.
A positive cash flow from operating activities is a good sign that a company is generating enough cash to meet its current financial obligations.
For most companies this is where the problems will begin – often with cash management. For example, maybe their accounts receivable are not quick enough especially compared to the accounts payable commitments, thus relying on debt to get them through the gaps. Or perhaps the inventory turnover is not high enough and a lot of cash is stuck in product.
- Assessing solvency
The cash flow statement can also be used to assess a company’s solvency, or its ability to meet its long-term financial obligations.
The investing activities section of the cash flow statement shows the net cash used in investing activities, which is an indicator of a company’s capital expenditure.
A negative cash flow from investing activities may indicate that a company is investing heavily in its future growth, but it may also indicate that a company is facing financial difficulties.
Often when a company hays surplus they feel the need to invest it (which does make sense) but the key here is to keep some liquid cash available, especially depending on issues in the Operating side of things.
- Assessing profitability
The cash flow statement can also be used to assess a company’s profitability. The operating activities section of the cash flow statement shows the net cash provided by operating activities, which is an indicator of a company’s cash-generating ability.
A positive cash flow from operating activities indicates that a company is generating more cash than it is spending on its primary business activities, which is a good sign for profitability.
Conclusion
The cash flow statement is a critical financial document that provides insights into a company’s liquidity, solvency, and ability to generate cash. It’s an essential tool for assessing a company’s financial health and can be used to evaluate
