To understand a company’s profitability, we often refer to the income statement, which tells us how much the company earned or lost during a financial year. However, when we look at these figures, it becomes difficult to ascertain how much cash the company actually generated from its core business operations and how it utilizes this cash income.
This key information can be easily found in the cash flow statement, which only reports the company’s cash transactions and indicates how much cash it generated from its operations and how it was used.
In this blog, we will learn about a cash flow statement, its components, and how it is calculated. We will also explore how the cash flow statement can be used in stock market analysis.
Cash flow is a critical financial metric that tracks the movement of money into and out of business over a specific period. It provides valuable insights into a company’s financial health and operational efficiency. Understanding cash flow is essential for effective financial management and decision-making.
Cash flow can be primarily categorised into Operating cash flow, Investing cash flow, and financing cash flow. Each type represents different sources and uses of cash within a business. Let’s understand each of these types in detail.
These are the cash transactions from operating activities like buying and selling goods and are related to the business’s daily operations. It indicates the cash generated or used in the normal course of business.
It includes cash transactions like cash received from customers, cash paid to the suppliers, cash paid to the workers, etc.
Operating cash flow ratio= Current liabilities / Operating cash flow
Investing cash flow refers to the cash transactions related to the
purchase or sale of long-term assets, such as property, equipment, or investments in securities.
Simply put, these are the cash transactions that impact the business’s long-term assets. They also include any long-term investments made or redeemed by the company.
Net Investing Cash Flow = CapEx/purchase of non-current assets + marketable securities + business acquisitions - divestitures.
Finance or capital is a core business requirement, as it helps finance the company’s operations and investments. Therefore, businesses need to raise capital continuously and regularly repay it.
Financing activity records transactions related to raising and repaying capital, such as the Issuance of Equity, dividend payment, receiving loans, repayment of loans, etc.
Net Financing Cash Flow = Cash flows from issuance of equities and debts – (Dividends + Interest + Stock repurchase + repayment of debt + repayment of lease obligations + dividend distribution tax)
Net cash flow refers to the amount of money that flows in and out of a business during a specific period, typically a month, quarter, or year. It represents the difference between the cash inflows (such as revenue from sales, investments, and financing) and the cash outflows (such as expenses, operating costs, and taxes) generated by the business operations. Positive net cash flow indicates that the business is generating more cash than it is spending, while negative net cash flow suggests that the business is spending more cash than it is bringing in. Net cash flow is a profitability metric for assessing a company’s financial health, liquidity, and ability to meet its financial obligations.
Net Cash Flow = Net Investing Cash Flow + Net Financing Cash Flow + Net Operating Cash Flow
The cash flow statement is a key financial statement that describes all the business’s cash transactions for a particular period. Simply put, it is the cash summary of the business that tells you where the business has received cash (Inflows) and how the cash has been used or utilized (Outflows), categorized into three sections:
The main purpose of the cash flow statement is to help stakeholders understand how a company generates and uses cash, providing insights into its liquidity, solvency, and overall financial health.
The Cash Flow Statement is an important financial statement for management, investors, and other stakeholders owing to its host of benefits. Here are some of the benefits of the cash flow statement that make it crucial:
The cash flow statement is a crucial financial statement as it tells you about the overall cash management of the company. Let’s look at some of the uses of cash flow analysis:
The cash flow statement, Income Statement, and Balance Sheet statement are three important financial statements that every business entity must prepare at the end of the financial year. However, each statement is totally different and has a different purpose.
Let’s understand the difference between them by the following table:
Objective
Represents the business’s financial position at a specific point in time, showing the year-end balance of each asset, liability, and equity.
Reports a company’s revenues, expenses, and net income (or loss), typically quarterly or annually.
Provides details about the cash inflows and outflows of business for a specific period, usually quarterly or annually.
Key Components
Assets, liabilities, and equity.
Revenues, expenses, and net income (or loss).
Operating activities, investing activities, and financing activities.
Formula
Assets = Liabilities + Shareholder’s Equity
Net Income (or loss) = Revenue – Expenses
Net Cash Flow = Cash Flow from Operating Activity +Cash Flow from Investing Activity + Cash Flow from Financing Activity
Basis
Accrual basis (Transactions are recorded when they occur, regardless of when cash is exchanged)
Accrual basis (Records all revenue and expense transactions, irrespective of whether cash was received/ paid or not)
Cash basis ( Records only cash transactions)
Focus
Focuses on the financial position of the company.
It focuses on evaluating the profitability of the company.
It focuses on the company’s cash inflows and outflows.
Cash Flow can be calculated using two methods: direct and Indirect. Both methods will give you the same closing cash balance; however, the only difference between the methods is in calculating cash flow from operating activities. Let’s first start with the direct method.
Direct method: The direct method only considers cash transactions related to the core business activities, such as cash received from customers, cash paid to suppliers, employees, etc.
Cash Flow from Operating Activities = Cash Received from customers- Cash Paid to Suppliers - Cash Paid for Wages - Tax Paid - Other Operational Expenses Paid in Cash
Indirect Method: The indirect method is slightly different from the direct method. While the direct method only involves cash transactions, the indirect method reconciles the business’s net income to calculate net operating cash flow.
It starts from net income as per the income statement, and then adjustments related to non-cash expenses, non-operational gains or losses, and changes in working capital are made to calculate cash flow from operating activities.
Cash Flow from Operating Activities = Net Income Adjustments to reconcile net income + Depreciation and Amortization Expenses + Loss on sale of fixed Asset - Gain on sales of Fixed assets Changes in Working Capital + Increase in Accounts Payable + Decrease in Accounts Receivable - Decrease in Accounts Payable
The structure of the cash flow statement is broadly divided into three sections: Operating activities, investing activities, and financing activities.
The first section starts with cash flow from operating activities, followed by cash flow from investing activities, and finally from financing activities.
After this, the net change in cash flow is calculated by adding the cash flows of all three activities. Finally, the beginning cash balance of the year is added to the net change in cash flows to determine the closing cash balance.
Cash Flow from Operating Activities (A)
Cash Flow from Investing Activities (B)
Cash Flow from Operating Activities (C)
