HOW TO ANALYZE A CASH FLOW STATEMENT

Are you familiar with the saying, “cash is king’?

Well, when it comes to investing, cash flow is king! Cash isn't effective if it is not liquid enough to flow. While cash is important, cash flow is what makes a business attractive to investors and stakeholders. This is because the amount of cash flow a business has is an indicator of how well the business is doing financially. Just by analyzing a cash flow statement of a business, anyone can understand the financial position of that business because it provides information about the operational efficiency of a business which can be used to predict the value of the business on the stock market. This is because as simple as a cash flow statement looks, it provides the analyst with critical information that can be used to make intelligent decisions about the position of? a business to investors and the long term sustainability of the business.

In this article, I am going to go over how to analyze a company's cash flow statement in simple terms so anyone can understand regardless of their background.

The first step to analyzing a cash flow statement or any financial statement for that matter is to know what to look for. When you understand what to look for, you are already on your way to analyzing the statement like a pro.

To begin, there are certain terms to define, one of which is the statement itself. A cash flow statement is a financial statement that provides a comprehensive summary of the amount of cash that comes in and goes out of a business, otherwise known as the cash inflows and cash outflows of? a business, over a given period of a business’s operation. It is also called the statement of cash flows.

Cash flow statement is key because it answers the vital questions of a business; “How is cash generated?” “What is the generated cash used for?” “where should the cash generated be directed instead?”

It tells the investors and stockholders how much cash a business is currently generating and how much cash a company is able to generate over a period. And since this is what determines a company's value in the stock market, the cash flow statement is one of the most vital statements to potential and existing investors.?

In a cash flow statement there could be both positive and negative numbers; a positive number represents cash inflow of the business while a negative number represents cash outflow of the business.

Typically, a cash flow statement is made up of three main sections: Section 1 summarizes all operating activities of the business. Section 2 summarizes all investing activities of a business and the last section, which is section 3 summarizes all financing activities of a business.

The first section which is usually the operating section will present any sources of cash the business generates and the business activities that use up generated cash. Simply put, the cash generated from the business in the form of sales of goods and or services of the business, interest payments, income tax payments, payments made to suppliers of goods and services used in production, salary and wage payments to employees, rent payments and all other types of operating activities.

The next section is the investing activity section of the cash flow statement this section includes any sources and uses of cash from a company's investments so that would include purchases of property plant and equipment investments the business made in other companies and money spent on acquiring other businesses or companies the investing activity section is almost usually? a negative number because the cash generated from the business has to leave the business to acquire these investments. especially for companies that are growing as they are using that cash to grow the business through investing in things like new locations, new equipment to make more products and increase cash inflow.

The third and final section is the financing activities section which reflects all the inflow and outflow of cash as a result of financing activities including the cash from investors or debt as well as? dividends payments for stock repurchases and repayment of debt are also included in this category.

Here's a very basic example of a cash flow statement:

Bo Business Solutions - Cash Flow Statement for the Year Ended December 31, 2023

Operating Activities

Net Income ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?$500,000

Adjustments for Non-Cash Items:

Depreciation and Amortization? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?$50,000

Changes in Working Capital:

Increase in Accounts Receivable? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?$(10,000)

Decrease in Inventory? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?$20,000

Increase in Accounts Payable? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? $(15,000)

Increase in Accrued Liabilities ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?$5,000

Net Cash Provided by Operating Activities? ? ? ? ? ? ? ? ? ? ?$550,000

Investing Activities

Purchase of Property, Plant, and Equipment? ? ? ? ? ? ? ? ? $(30,000)

Sale of Investments? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?$15,000

Net Cash Used in Investing Activities ? ? ? ? ? ? ? ? ? ? ? ? ? ?$(15,000)

Financing Activities

Issuance of Common Stock ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? $25,000

Payment of Dividends? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? $(12,000)

Repayment of Long-Term Debt ? ? ? ? ? ? ? ? ? ? ? ? ? $(20,000)

Net Cash Used in Financing Activities ? ? ? ? ? ? ?? ?$(7,000)

Net Increase in Cash $528,000

Beginning Cash Balance $200,000

Ending Cash Balance $728,000

Using the example above, I will explain in very basic terms how to read the cash flow statement of Bo Business Solutions for the Year Ended December 31, 2023.

Please note that this is just an example and none of these statements are true.

Starting with the operating activities, the first thing to notice is the net income, because this is where all operating activities will be deducted from or added to. It is the initial summary. The next thing to do is to separate the report into cash and non cash items. This is because the statement is not just used to determine income, it is also used to determine a businesses liquidity. You don’t need to draw it up, but as an analyst, you can separate them in your books. The next thing to do is to understand which activity on the statement is an asset and which is a liability.

Simply put, an asset is anything the business owns and a liability is anything the business owes. Assets? are represented as positives and liabilities are presented as negative. But there are other instances where they do not follow this rule.

For example, on the cash flow statement, an asset can also be negative when a business owes more to the creditor than what is at hand. Since the business is in a deficit anyway, the asset will be represented as a liability. And a liability can also be represented as positive when it is accrued, this is because a cash flow statement believes that the cash is still in the business’s account.?

Please note that this rule does not necessarily apply to other financial statements as there are specific rules for specific statements since their goal is different. A cash flow statement for instance is only concerned about how cash is coming in and going out, and because of this, an activity is only recorded to have occurred after cash has left or entered the businesses. For this reason, a liability can be recorded as a positive and an asset can be recorded as a negative against the rule and the statement will still be correct if they interpret the exact cash movement of the business.

With this in mind, we can begin.

From the example above, the business generated $500,000 in net income as at December 31st, 2023. Using this as a starting point, you account for depreciation and amortization by adding its value $50,000, you less for account receivable $10,000 (Account receivable is an asset but is represented as negative in this case as explained above). You add a decrease in inventory of $20,000 because it is an indication of sales, which is an implication of cash inflow. You less account payable of $15,000 and you add accrued liabilities of $5,000 (as explained above). These adjustments to the net income will bring us to a total net cash value of $550,000 from the business’s operating activities for the year ended December 31st 2023.

For investing activities, the figures are almost always negative unless for income generated from sales of investments. This is because cash has to leave a business to enter an investment. From the example above, you start by accounting for all purchases and use the result as a base for your calculation. Which is $30,000 in negative. Then you add sales of investments $15,000 and you have a total net cash from investing of $15,000 in negative.

For financing activities, you have issuance of stock as an inflow of $25,000, from it you have less payment of dividends as an outflow of $12,000, you also less repayment of debt as an outflow of $20,000. This will bring the net cash from financing to a negative $7,000.

The next thing to analyze is the net increase in the business for the recorded period. You get that from adding all net cash across the sections.

$550,000+ (-$15,000) +(-$7,000)= $528,000

Because this is a positive value, it is a net increase of cash in the business at the end of the period recorded.

The final thing is to compute the ending cash balance. This is gotten from adding the cash balance at the beginning of the period and the cash balance at the end of the period. From the example above, the cash balance at the beginning of the period was provided to be $200,000. So you simply add both balances to obtain a closing cash balance for the business.

$200,000 + $528,000 = $728,000, which is the closing balance for the business for the year ended December 31st, 2023.

Of course a cash flow statement for an actual business with actual activities is way more complex than this. However, this simple hypothetical example illustrates how a cash flow statement provides insights into a company's cash inflows and outflows across different activities, helping investors assess its financial performance and liquidity.