Analyzing the Cash Flow Statement
The Cash Flow Statement (CFS) or “statement of cash flows” is a financial statement that records the cash and cash equivalents entering and leaving a company. The “cash inflow” is the money coming into the business, while the “cash outflow” is the money going out. Cash is the lifeblood of any business since, without it, no business can function. A fundamental investor must have an accurate picture of cash flow to effectively evaluate a company. The CFS provides investors with the opportunity to better understand a company’s operations, its cash flow sources and how the business is spending its money. As a tool for fundamental analysis, the cash flow statement can help determine the viability of a company, particularly its ability to meet short-term liabilities.
The Three Parts of the Cash Flow Statement
The cash flow statement is partitioned into three segments:
Operating activities describe the production, sale and delivery of products and the company’s collection efforts.
Investing activities might include purchasing an asset (such as land or equipment) or any loans the company might have made.
Financing activities detail cash inflows from company investors and outflows (dividends) to shareholders.
Proper Analysis is Dependent Upon Consistency
A thorough review of a company’s cash flow statement with comparisons to previous periods can help a fundamental investor in assessing the financial health of an organization. The key to proper analysis is in consistency- adhering to specific criteria regarding which types of cash flows belong in which of the three segments. Any meaningful comparisons between statement periods rely on uniform definitions.
One of the benefits of analyzing a cash flow statement is that the investor can determine if there has been a change in efficiency (good or bad) in any of the revenue-generating processes within the company.
What to Look for When Analyzing Cash Flow Statements
If the cash from the company’s operating activities is consistently higher than the company’s net income, then the company’s earnings are considered to be high quality. Otherwise, investors would be left to wonder why net income is not being converted into cash.
A company can increase its perceived shareholder value by consistently generating more cash than it is using.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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