Cash flow statement is one of the three financial statements that every company is required to produce. It is a report that shows the inflow and outflow of cash in a business for a particular period. The cash flow statement gives a clear picture of the company's liquidity, solvency, and financial stability. It is essential for investors, creditors, and other stakeholders to understand how to read a cash flow statement to make informed decisions. In this article, we will discuss how to read a cash flow statement.
Cash flow statement is divided into three sections: cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities. Let us discuss each section in detail.
Cash flow from operating activities:
The cash flow from operating activities section shows the inflow and outflow of cash from the company's core business operations. It includes cash received from customers, payment to suppliers, payment to employees, payment of taxes, and interest paid. It is essential to note that cash flow from operating activities does not include non-cash transactions such as depreciation and amortization.
To analyze the cash flow from operating activities, we need to look at the net cash flow from operating activities. A positive net cash flow from operating activities means that the company is generating cash from its core business operations. On the other hand, a negative net cash flow from operating activities indicates that the company is using cash to fund its operations, which may not be sustainable in the long run.
Cash flow from investing activities:
The cash flow from investing activities section shows the inflow and outflow of cash from the company's investments. It includes cash inflow from the sale of property, plant, and equipment, cash outflow for the purchase of property, plant, and equipment, and cash outflow for the purchase of investments.
To analyze the cash flow from investing activities, we need to look at the net cash flow from investing activities. A positive net cash flow from investing activities means that the company is generating cash from its investments. On the other hand, a negative net cash flow from investing activities indicates that the company is using cash to fund its investments, which may not be sustainable in the long run.
Cash flow from financing activities:
The cash flow from financing activities section shows the inflow and outflow of cash from the company's financing activities. It includes cash inflow from the issuance of shares, cash inflow from the issuance of debt, cash outflow for the repayment of debt, and cash outflow for the payment of dividends.
To analyze the cash flow from financing activities, we need to look at the net cash flow from financing activities. A positive net cash flow from financing activities means that the company is generating cash from its financing activities. On the other hand, a negative net cash flow from financing activities indicates that the company is using cash to fund its financing activities, which may not be sustainable in the long run.
Analyzing the overall cash flow statement:
After analyzing each section of the cash flow statement, we need to look at the overall cash flow statement to understand the company's financial position. A positive net cash flow means that the company is generating cash, which is a good sign. On the other hand, a negative net cash flow means that the company is using cash, which may not be sustainable in the long run.
It is also essential to compare the cash flow statement with the income statement and balance sheet to understand the company's financial position fully. If the company is generating a positive net income but has a negative net cash flow, it may indicate that the company is not managing its cash flow well. On the other hand, if the company is generating a negative net income but has a positive net cash flow, it may indicate that the company is managing its cash flow well.
Reading a cash flow statement is essential for investors, creditors, and other stakeholders to make informed decisions. It is essential to understand each section of the cash flow statement and analyze the net cash flow from each section. It is also important to compare the cash flow statement with the income statement and balance sheet to understand the company's financial position fully. By understanding how to read a cash flow statement, investors and creditors can make informed decisions about investing or lending to a company.