3 March 2011

Business Cashflow: Read Between The Lines!

This is part 2 of the financial statement series. You can read part 1 HERE

In this post, I will be discussing how to read a cashflow statement in conjunction with the other financial statements in order to get a clear picture of how well a company is performing.

The cashflow statement is an interesting document to keep an eye on, as it tracks cash flowing in and out of the business at a specific point in time. Because the availability and flow of cash is the most important thing to a business or investment, I quickly realised that knowing how to do this can put you at an advantage and allow you to see what is happening to any business or investment. It shows what is happening within the company, usually on a month by month basis, which enables you to have a more detailed idea on things that are happening currently and any cash crises that may be on the way.

It shows where the money is coming from and how it is being spent and uses information recorded on the balance sheet and income statement to do so.

A cashflow statement is typically split into 3 parts

Operating Activities
Investing Activities
Financing Activities

Before we begin I will mention that for each of these 3 parts there will be information relating to cash receipts and cash payments. The cash receipts is simply the money coming in to the business and the cash payments is the money going out of the business.

So…lets crack on with the first!

Operating Activities

The operating activities have a lot to do with the general day to day costs of running the business .The cash receipts for operating activities documents things such as the sale of goods/services, interest revenue/dividend revenue etc. Cash payments include things such as interest expense, taxes, rent, payroll etc

Investing Activities

The cash receipts in this area are usually derived from the sale of property and equipment. Things like the sale of segments of the business and particular investments are also included. As expected, cash payments include things such as the purchase of property, equipment, investments and business segments.

Financing Activities

This generally includes the purchase and reissuance of company stock and the payment of dividends to those who bought an interest in your company. The cash payments side deals with repurchasing company stock and paying dividends to shareholders, while the ‘cash receipts’ side deals with things such as issuing stock and the borrowing of money.  

In making calculations on a balance sheet, there are 2 ways the information can be gathered/presented:-

Direct Method

With this method, figures are calculated at the time of the actual transfer of cash into the company bank accounts. This is commonly referred to as 'Cash Accounting'.

Indirect Method

‘Accrual accounting’ recognizes transactions at the time it occurs, meaning that the picture can be more accurate or at least more helpful. The current cash inflows and outflows i.e. [Cash payments and receipts] are combined with the expected cash that is due to come in from a sale [which may not have been paid yet] along with estimates of future inflows and outflows.

Regardless of which method is used, the end result should alwsy be the same!

How does a cashflow statement look?

Here is an example of how a typical cashflow statement might look:-

We should be looking to make sure that a company has a positive cashflow, particularly in the operating area. This shows that it has money available and is going strong. As a company grows,  the investment section becomes a lot more exciting because, if done properly, this dramatically increases the size and stature of the company. Finally the financing section will show changes to available cash due to various financing activites of the company such as dividend payouts etc. By understanding the cashflow statement, you are immediately at an advantage in terms of being able to read and interpret how well a company is doing.

So there we have it, this is how we interpret a cashflow statement and its meaning. For further reading on this subject check out www.natbic.org which I found to be invaluable in providing general information on many aspects to do with business!

The series on knowing how to read the number is: Part 1, Part 2

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