This Is What A Company’s Cash Flow Statement Can Tell You About Its Business | A Beginner’s Guide to Fundamental Analysis
When venturing into or preparing to invest in a business, you would have to look at its cash flow. Naturally, the net income is the influential factor or the prime meter gauge. However, one can’t skip learning and understanding how money flows in and out of a business. Aside from the bottom line figure, a company can be differentiated from the rest by the way their funds are managed.
Cash Flows Drives the Business
The survival of any business depends on its ability to generate cash, not temporarily, but for the long haul. Money makes the world go round, and it makes businesses grow. Hence, it’s all about sourcing funds and spending them to rake in the profits.
In general, a company needs a ‘positive’ cash flow which means its cash inflows should always exceed cash outflows. That’s the natural consequence of a business desiring to operate for years on end.
The Cash Flow Statement
The Cash Flow Statement completes the roster of financial statements that you will see in a company’s annual report. It’s one of three major corporate disclosures that investors and creditors need to obtain to better analyze a company’s performance. In the accounting parlance, the official term used is the statement of cash flows.
The two other financial statements are the income statement (profit and loss statement) or the balance sheet. You refer to the income statement if you’re reviewing revenues and costs to find out if the company is losing or making money. The balances sheet depicts the company’s financial health based on its assets, liabilities, and stockholders’ equity.
Meanwhile, the cash flow statement is the report that shows the cash produced and expensed out during the time interval or period indicated in the statement. In essence, the information contained in the cash flow statement weaves together the income statement and balance sheet. It’s a recording of all money matter transactions in a specified accounting period.
The Movements of Cash in a Company
The cash flow statement divulges the company’s sources of money (cash inflows) and where money is expended (cash outflows). There are three areas in cash flows that you need to know to clearly understand the whole money affairs. They are broken down into specific activities:
- Cash flow from operations
This segment measures the actual cash used or delivered through the company’s normal course of business. It shows the company’s ability to spawn positive cash flows consistently.
If a company is in engaged in selling software, then the cash flow from operations comes from this normal business activity. It’s the ‘bread and butter’ or sustenance of the company.
- Cash flow from investing activities
When a company acquires or sells capital assets, this activity is reflected as cash flow from investing activities. Capital assets are items that possess a useful economic life of a year or more. They are also documented as income-producing assets.
It should be stressed that each company has the prerogative to determine which items may be considered as capital expenditures (capex). Hence, there is may be differences when comparing the cash flow from investing activities of one company with another.
- Cash flow from financing activities
Financing activities pertain to the cash flow between a company and its shareholders as well as its creditors. It can be in the form of sale of stocks, dividend payments, loan proceeds, or debt repayment.
Seeing negative numbers might be sounding off an alarm at first glance. However, it can mean something positive like retiring debt or distributing cash dividends to shareholders and investors. Read the line items corresponding to the figures to know the reasons behind the movement of cash for such activities.
An Illustration of a Statement of Cash Flows
CapitaLand is a publicly-listed company in Singapore and is one of Asia’s largest real estate companies. The company owns and manages a global portfolio that is valued more than S$78.0 billion as of December 31, 2016.
It has established its presence in 20 countries and caters to various businesses related to real estate. As such, their Consolidated Statement of Cash Flows is a fine example of how the three cash flow activities are presented in detail.
CapitaLand’s core markets are in Singapore and China but the company has business interests elsewhere. They are into integrated developments, shopping malls, serviced residences, offices, residential property, real estate investment trusts (REITs), and funds. Each of the cash flow activities are recorded in the consolidated cash flow statements to show the reader where cash is utilized.
Giving Importance to Cash Flows
Cash flow is a vital aspect of a business. Some investors view the statement of cash flows as having the same value as the income statement and balance sheet, if not better. Cash fuels business activity and therefore cash availability or lack of it is critical for the company. It tells the exact cash position that could impact on revenues.
Cash flows are essential to keep the business going. A business is financially strong if it has a high operating cash flow. Having a positive cash flow means the business is able to sustain operations and pay for salaries, debts and other payables.
There are occasions wherein a company needs to take a position on an investment with profitable returns in the near-future. Although it would mean a negative cash flow for now, the spending makes good business sense at the moment.
On the opposite side, insufficient cash flow means a business is hard-pressed to sustain normal operations. Knowing your cash position can lead to sound financial decisions. An efficient funds management system can bring in increased revenues, lower overhead expense that will ultimately redound to higher profits.
Cash flows determine a company’s financial health
When you come across a cash flow statement, you can calculate the operating cash flow. Subtract the financial obligations or debts, add depreciation, and add/subtract working capital as applicable. The result will give you a more truthful picture of a company’s financial health.
Understanding cash flows will also assist you determine the difference between ‘ordinary’ revenue and ‘real’ profit. A company may be generating significant revenue but because of bloated expenses and obligations, profit may be smaller or none at all. In conclusion, cash flows can make or break the continued existence of a business entity.
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