Preface: Statements of cash flows should be analyzed along with a balance sheet and income statement. What is a statement of cash flow…continue the read.

What Can You Learn From a Statement of Cash Flows

 

A statement of cash flows shows the transfer of cash in and out of a business. It is usually measured during a specified time period such as a year, or quarter. Measurement of cash flow provides data points for analysis on a corporate financial position or valuation at a specific time. Net cash flow consists of three segments: operational cash flows, investment cash flows, and financing cash flows.

Operational cash flows include net income and changes to working capital, i.e. cash sources and uses from internal business activities. Operating cash flow is also called free cash flows and is the amount of cash a business generates from revenue producing activities. Operating cash flow does not include cash from investments or capital activities. Operating cash flow provides a more accurate picture of a corporation’s current financial position than does say net income trends. Operating cash flow increases when cash is received from decreases in inventory or accounts receivable, or increases in accounts payable or accrued expenses such as payroll. For instance when inventory is sold to a customer the inventory balance will decrease = an increase in cash, but accounts receivable will increase the amount of inventory (COGS) and net income = decrease in cash, so the change on operating cash flows would zero on the sale (net income + decrease in inventory – increase in accounts receivable). Therefore, operating cash flow measures the change in working capital in its entirety for a period.

Investment cash flow details cash received from sale of property or investment assets, i.e. stocks or notes receivable; or cash invested in property or investment assets such as bonds or real estate. Investment cash flows provide a segregated disclosure of cash uses and sources from capital expenditure and cash management such as an investment portfolio.

Financing cash flows is the cash received from the issuance of debt and equity or cash paid out in dividends, repayment of loans, or treasury stock repurchases. An increase in a line or credit would be a source of cash.

How can you make sense of operating cash flows? For one, decreases in cash from an increase in accounts receivable is an indicator that a company is being too aggressive in selling product, and could be posting bad debt expenses in the future. On the other hand, if a business is developing at a slow upward trajectory in accounts receivable would be anticipated. Determining why balances are increasing/decreasing is important. Inventory level increases resulting in decreases in cash flow and indicate that management is not efficient in manufacturing or has a narrow supply pipeline that could prohibit the ability of the business to respond quickly to market winds.

Accounts payable increases result in an increase in cash so measure the balance of this change to other operating asset changes, because this will increase results in cash uses in future periods.

Cash uses on capital expenditures are necessary for a developing business but negative operating cash flows and net uses in cash on investment cash flows are an indicator of financial turbulence.

It is often helpful to look at trends on a businesses net increase or decrease in cash (net operating, investing, and financing cash flows) for a series of years or quarters to analyze the cash flow strength of business. The same analysis can be applied to operating cash flows.

The higher the net income number as a percentage of operating cash flows the stronger the financial position of the business. The wicket of continually positive operating cash flows and positive net income is sure indicator a business is thriving. Negative operating cash flows in sequential periods is an indicator of a financial cycle trend of lackluster performance, even if the business has positive net income.

Statements of cash flows provide a clear read on financial winds.

Summary: Statements of cash flows are a key metric to financial management decisions. If your accountant is not preparing a statement of cash flows for your business, you need to begin requesting that statement, and reading it.