How to Read and Understand a Cash Flow Statement

Cash Flow Statement

The cash flow statement tracks the changes in your business’s cash position over a set period of time. It shows inflows from operations, investment activities, and financing sources minus outflows for business or investing decisions.

These results can be used to analyze how effectively you are utilizing capital and generating sustainable revenue growth.

For instance, if you are a business owner, you may want to look at the cash flow statement to see if you have been able to maintain a healthy level of cash on hand. This will help you make better financial decisions for your company in the future.

Why Is the Cash Flow Statement Important?

The cash flow statement is important because it gives you a snapshot of your company’s financial health. It can help you identify where your business is generating and spending its cash.

This information can be used to make informed decisions about your business’s future, such as whether you should expand, invest in new equipment, or hire more employees.

In addition, investors and creditors will want to look at your cash flow statement to see how profitable you are as a company.

If your sales revenue is not generating enough cash from operations, that may be a sign that the business cannot support its high debt load or other obligations.

Similarly, if your company routinely has negative cash flows from operations, those numbers should be viewed as a warning sign that you are not generating enough revenue to cover your costs.

How To Read a Cash Flow Statement

The cash flow statement is usually divided into three sections: operating activities, investing activities, and financing activities.

Let’s take a closer look at each one.

Operating Activities

This section of the cash flow statement measures the operating revenue and expenses generated from a company’s core business.

The net result of the section is called cash flow from operations (CFO). This number can be found in the middle section of the cash flow statement.

An example of an operating activity would be a business selling goods and services. The revenue from those sales would be included in the cash flow from operations, as well as the costs of producing those goods and delivering the services.

Investing Activities

The investing activities section of the cash flow statement tracks how a company is spending its cash to purchase physical assets such as real estate, equipment, and vehicles.

It also includes cash generated or used by investing activities other than the core business, such as buying and selling investments in stocks or bonds.

The net result of the section is called cash flow from investing (CFI), which can be found on the right side of the statement.

Example of an investing activity would be a company buying a new piece of machinery for its factory. The purchase price of the machinery would be included in cash flow from investing along with any depreciation or amortization expenses throughout the useful life of the asset.

Financing Activities

This section measures how cash flow is affected by borrowing and repaying debt, issuing or buying back stock, paying dividends to shareholders, or receiving payments from other sources.

The net result of the section is called cash flow from financing (CFF), which can be found on the left side of the statement.

An example of a financing activity would be a company issuing new bonds to raise cash. The proceeds from the bond sale would be included in cash flow from financing, as would the payments made on the bonds over time.

How To Understand a Cash Flow Statement

For the cash flow statement to be useful, you must know what each section represents.

The first step is determining whether your company is generating positive or negative cash flows.

Positive_Cash_Flow

If your company has positive cash flows from operations and investing activities, then it has generated enough money to support its business and can use any excess cash to provide returns for investors.

Negative_Cash_Flow

If your company has negative cash flows from operations and investing activities, then it is spending more than it generates and will likely need help from an outside source like debt or equity financing to stay afloat.

When determining whether a business is healthy or not, you also need to look at the cash flow statement trend.

A business with positive cash flow from operations but negative cash flow from investing and financing is in a much better position than one with negative cash flows from all three categories.

Who Should Be Reading the Cash Flow Statement?

Although investors and creditors will always want to look at the cash flow statement, they won’t be the only ones.

Business owners and managers should keep an eye on this financial statement because it can provide insight into how well a company is performing.

An investment banker or potential investor will use the cash flow statement to determine whether the company has enough cash on hand to make an initial public offering (IPO), if it can repay investors at the time of sales, and how much money it’s bringing in over several years.

A loan officer will use the cash flow statement to see how much a company is spending and whether it has enough cash on hand to make loan payments.

The cash flow statement can also help you understand how a company is being funded and what its long-term debt situation looks like.

You can read more about Cash flow statements from Investment Activities now that we’ve covered the basics. Learn more here: Cash Flow From Investing Activities

The Bottom Line

The cash flow statement can be used to determine a company’s short-term and long-term financial health, as well as to evaluate its business strategy.

If you want to make an investment or consider loaning money, this is the first place you should look.

When reading a cash flow statement, keep in mind how a positive or negative trend can affect the company’s overall financial health.

Cash flow is defined as the net amount of cash and cash equivalents brought in and used by a company during a certain period of time. This statement measures inflows and outflows of cash, not profits.
The three categories of activities on a cash flow statement are operations, investing, and financing.
The cash flow statement is important because it provides a snapshot of a company's financial health and shows how well it is generating and using cash. This information can be used to make informed decisions about investments or loans.
The cash flow statement is typically updated on a quarterly basis. This is the frequency that public companies will report their cash flow. However, private companies may show it as often as every month or as infrequently as once a year.
The cash flow statement should be read by investors, creditors, business owners and managers, investment bankers, and loan officers.

Cash Flow Statement Subtopics

  • Cash Flow Planning

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.

Leave a Comment