How to Read a Cash Flow Statement

As an investor it is important to see exactly where the cash is coming and going out of the company you have an interest in. If you can read a cash flow statement and understand the information it is showing you, this is a valuable skill to have. This financial document is useful because it shows the details of cash inflows and outflows occurring in a business.

To understand how to read a cash flow statement you should know its purpose, the information contained within, how to interpret and understand the three business activities and how it relates to the importance of cash flow. Here is a quick run-down of what you should know:

The intention of the cash flow statement helps illuminate the specifics of the cash receipts and payments which occurred during the accounting period. Managers, investors and lenders all have a vested interest in the financial health and stability of a company they are a stakeholder in.

Information contained within the cash flow statement is extracted from the company’s balance sheet. While the cash amount listed in the company’s balance sheet is useful when examining the current and liquid assets belonging to a company, it does not illustrate how the cash balance was achieved and where the money came from.

The statement of cash flows it allows interested parties to more closely examine a business’ cash position and interpret where the company stands from a cash perspective. The cash flow statement specifies exactly how money has been used for the business’ operating, investing and financing activities.

*Operating activities. By calculating the difference between the total cash receipts and cash payments, otherwise known as revenue and expenses, this shows how money flowed through the business during operations. This difference is the net cash which has been generated from operating activities and is important because it is money earned not borrowed.

*Investing activities. When a business re-invests money back into the company for items such as land, equipment or buildings, this is done with the intentions of increasing value. After the receipts and payments for these investments are calculated, the result is the net cash balance from investing activities.

*Financing activities. Financing activities are another essential area to examine because it shows what money was borrowed and how much common stock was issued to shareholders. Once the inflow and outflow of this cash has been calculated, the result is the net cash provided by financing activities.

The totals of each business activity show the net increase or decrease of cash during the specified accounting period. When you add this to the company’s beginning cash balance, it determines the amount of cash available to use.

Since cash is a vital asset and one all businesses need in order to stay profitable, any parties who have a vested interest in the company will want to pay close attention to cash flows. As an investor, it is a good idea to be kept apprised of where cash comes from and what it is being spent on.

Companies that have little or no cash flow cannot flourish and have a higher probability of failure. As an investor this is useful to see when deciding where to invest your money. When you evaluate each activity segment of the cash flow statement, it is helpful because the balances shown in each activity will offer you useful insight when you try and determine whether or not the business investment is a worthwhile one.

An example of this is if you see a large cash balance, but by examining each segment closely you can determine most of the money came from financing activities, this means the money was borrowed and will eventually need to be paid back with interest. On the other hand, if you take a look at the operating activities and see the bulk of the total cash balance was achieved through revenue gained this shows more stability in terms of the company’s financial health.

A cash flow statement will also help you determine a company’s ability to generate future cash flow, illustrate whether it can afford to pay off loans and if it has the ability to distribute dividends. The cash flow statement also helps assess a company’s liquidity and solvency which are important for seeing if the company can sustain and remain profitable.

Where cash money comes from is important factor and one which should not be overlooked if you have a financial stake in a particular company. The cash flow statement is a pretty easy to read document because the details contained in it are pretty straightforward. When considering your options to invest, it is a wise idea to examine the company’s cash flow statement.

While it is not the only statement you should examine when thinking about investments, the statement of cash flows is a useful and valuable financial tool for you to know how to read.