Summary: How to interpret your Cash Flow statement and ensure you are cash positive in your business. Includes cash flow statement example.
Whether you are an investor or running your own business, you need to understand your financial statements, they are the keys to the company!
They can warn of potential problems, and when used correctly, help determine what a business is really “worth”.
In the final instalment of our three part series, we will show you that anyone can learn how to read the final of the BIG THREE: the Cash Flow Statement.
There are three important parts of a company’s financial statements: the BALANCE SHEET gives a one-time snapshot of a company’s assets and liabilities (see interpreting your Balance Sheet), the INCOME STATEMENT which indicates the business’s profitability during a certain period (see interpreting your Income Statement) and the Cash Flow Statement.
Financial statements are based on accrual accounting, which takes into account non-cash items. It however confuses how much actual cash a company has available.
Some industries are more cash intensive than others – no business can survive in the long run without generating positive cash flow, although there is no norm.
One needs to aim for a business in which its cash inflows exceed its cash outflows.
An outflow of cash occurs when your business transfers cash to another entity.
It is essential that one does not record cash flow until it leaves the business’s hands. When you have a liability, one does not record the full capital amount, however monthly instalments or interest would reflect on the cash flow statement.
A cash inflow is income received from whatever source, into the business.
The majority of the inflow would be from clients and customers, or investment incomes, however on occasion there would be sale of assets or equipment which would add to your cash inflow.
Step 1: The Figures
These are recorded in different line items discussed below:
CASH ON HAND = OPERATIONS COSTS + ASSET INVESTMENTS + FINANCING
Section 1: Cash Flow vs Income
One should be aware that although a business may have a positive cash flow, it may not necessarily be profitable, or vice versa and you should analyse income statements along with cash flow statements to ensure you get the full picture.
This is the only statement where you can clearly see whether revenue has been collected or not, however you will not be able to see without the Balance Sheet whether all expenses have been paid.
There may be debtors which have longer payment terms, or non-current liabilities’ which have not fallen due as yet.
Section 2: Cash flow from operating activities
Quarterly or Annual cash flow statements report the cash generated and used during the time interval specified.
Operating cash flow and operating costs record how much the business has made or spent on a daily basis.
This includes cash that came in for the period and collections of sales previously made on credit, minus assorted regular expenses.
It is the most accurate assessment of how much money you have generated from your core business.
If your total net cash is glowing quarterly (or even better monthly) one should be very pleased.
Section 3: Cash flows from investing activities
Cash flow from investing activities records cash used or provided by the purchase and sale of income-producing assets.
If the business bought or sold long-term capital assets, for a profit or loss, the resulting figures would be included in this section.
These assets may be equipment, property, machinery, vehicles, furnishings, or investment securities.
Over time, you want to see that the business is able to pay for these investments with income from its operations and the liability associated to these investments reduces steadily.
Section 4: Cash flows from financing activities
Cash flows from financing activities reflects the flow of cash between a business and its owners/investors and creditors.
Negative numbers can mean the company is servicing debt but can also mean the company is making dividend payments and stock repurchases, which investors might be glad to see.
For listed companies, this is where cash flow from the sale of stocks and bonds, payment of dividends, or repayment of debt capital is recorded.
Step 2: THE BOTTOM LINE
When you look at a cash flow statement, the most essential item is the bottom line, ie the net increase/decrease in cash and cash equivalents.
This is a reflection of the overall change in the company’s cash and its cash equivalents over the last period.
If you check under current assets on the balance sheet, you will find cash and cash equivalents.
Step 3: THE FULL PICTURE
Cash flow statements are provided as part of all businesses’ financial statements, but there is no norm.
The principal industry of operation determines what is considered good cash flow levels to ascertain whether they will make it through the year, and through tough times.
To calculate operating cash flow compare the amount of cash generated to the outstanding debt.
Businesses with stronger cash flow are less vulnerable in tough times and stand a better change of servicing its long term liabilities and current creditors.
There is little room for misinterpretation, or indeed manipulation, in the Cash Flow Statement. Either a business has enough cash or it does not.
While a business that shows positive cash flow is of course desirable, companies that aren’t yet cash-flow positive present interesting opportunities for investment.
Example Cash Flow Statement Click Here to get a FREE 30 minute review of your Cash Flow and financials