How to read a cash flow statement

How to read a cash flow statement

Knowing how to read and interpret a cash flow statement may help you extract valuable information about a company’s financial health, whether you’re a working professional, business owner, entrepreneur, or investor.

Is your cash balance higher or lower than it was a year ago? What caused it to rise in the first place, and why did it rise in the second? What’s your reaction? If we were to ask a healthy Company the same question, I may get the cash flow statement as an answer.

The cash flow statement is used to determine how the firm earned and used cash during the period. After reviewing a company’s cash flow statement, we should be able to answer the questions regarding the increase or decrease of the company’s cash and cash equivalents.

The cash flow statement summarizes the cash spent or generated by the business as a result of its operating, investing, and financing operations.

What Is A Cash Flow Statement?

The goal of a cash flow statement is to show what occurred to a company’s cash over a specific time period, known as the accounting period. It displays an organization’s capacity to operate in the short and long term, based on the amount of cash coming in and out.

While the company’s balance sheet can tell me what the cash and cash equivalents balances were at the beginning and end of the quarter, it cannot tell us how the cash was created or used. The cash flow statement is a financial statement that shows how a company’s cash and cash equivalents were created and used.

Typically, the cash flow statement is divided into three sections:

  • Operating activities
  • Investing activities
  • Financing activities

The total of these three variables will indicate the overall rise or reduction in cash and cash equivalents during a specific period.

The Importance Of Cash Flow

Cash flow statements are one of the most important financial papers that a company may produce, as they provide crucial information on the company’s health. Regardless of your position, understanding how to read a cash flow statement and other financial papers will help you make better business and investing decisions.

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How To Interpret A Cash Flow Statement

When reviewing any financial statement, think about it from a business standpoint. Financial documents are intended to offer information about an organization’s financial health and condition.

Cash flow statements, for example, might tell whether a firm is in its early stages of growth or is well-established and lucrative. It can also tell whether or not a firm is in transition or on the decline.

An investor can determine that a firm with irregular cash flow is too risky to invest in, or that a company with positive cash flow is ripe for growth, based on this information. Similarly, a department head may examine a cash flow statement to determine how their department contributes to the company’s overall health and well-being, and then utilize that information to change their department’s actions. Internal choices like budgeting and hiring (or firing) personnel may be influenced by cash flow.

Cash flow is often shown as either positive (the company takes in more money than it spends) or negative (the company spends more money than it receives).

Positive Cash Flow

Positive cash flow shows that a company’s cash inflow exceeds its cash outflow during a certain time period.

Positive cash flow does not always imply profit. It’s possible to be profitable without having cash flow positive, and it’s also possible to have positive cash flow without generating a profit.

Negative Cash Flow

Negative cash flow occurs when your cash outflow exceeds your cash intake during a certain period, however it does not always imply a loss of profit. Instead, a mismatch in expenditures and income may be the source of negative cash flow, which should be remedied as soon as feasible.

Negative cash flow can also be produced by a company’s choice to expand and invest in future development, so it’s critical to look at changes in cash flow from one quarter to the next to see how the firm is doing overall.

How to Read a Cash Flow Statement

Cash Flow from Operating Activities, Cash Flow from Investing Activities, and Cash Flow from Financing Activities are the three sections of a cash flow statement.

Cash Flow from Operating Activities: This is your net cash inflow or outflow as a result of your activities, and it gives you a clear idea of whether or not your company model is viable.

Operating cash flow includes the following categories:

  • Net income
  • Non-cash adjustments such as depreciation
  • Changes in operating assets and liabilities

Cash Flow from Investing Activities: This refers to the purchase and selling of capital assets such as equipment and other businesses. This category includes renovations and improvements, as well as additional investments. These are long-term investments in the company’s prosperity.

Cash Flow from Financing Activities: Borrowings and repayments on term loans and lines of credit, as well as the sale and buyback of a company’s own stock (including employee stock options) and dividends, are all examples of financing cash flows.

How To Use The Cash Flow Statement With Your Other Financial Statements

Monitoring the movement of money in and out of your business over time might help you identify areas where you can improve or develop. Your three basic financial statements, when combined, provide you with the information you need to assess the health of your company.

While the cash flow statement reveals how much money you have in the bank, the balance sheet and income statement (commonly known as the P&L) illustrate how much money has changed hands.

Transactions are documented as they occur in companies that use accrual accounting. However, depending on the payment conditions of the transaction, there may be a time delay between the signing of the contract and the payment of the invoice.

When you combine the cash flow statement, the income statement, and the balance sheet, you can prevent a cash crisis (which might be disastrous if you didn’t realize the money wasn’t yet available). It also allows you to monitor the effectiveness of your AR. If you have a lot of income on your other financial statements that isn’t showing up on your statement of cash flows, you may need to focus on collections.

Cash Flow Statement vs Income Statement

A cash flow statement, unlike an income statement (commonly known as a profit and loss statement), illustrates how much cash your firm has available to operate the business at any one moment and gives historical information on your cash sources and uses.

Because cash flow and income statements might look at the same transaction in various ways, it’s important to know what they’re for. Depreciation, for example, is a non-cash item that is recognized as an expenditure on the income statement during the asset’s life. Depreciation, on the other hand, is added back to the cash flow statement because it does not reflect a real transaction that would lower your available cash.

Cash Flow Statement vs Cash Flow Forecast

A cash flow forecast employs a set of management assumptions to offer a forward-looking diagnostic model of what is expected to happen in the future, whereas a cash flow statement focuses on the present and recent past.

Cash flow statements and forecasts work together to show you how much operational cash you have on hand (liquidity), as well as your cash inflows and outflows, so you can better understand your company’s financial status.

As a result of this knowledge, you can forecast future cash flows and plan how much cash you’ll have accessible in the future. This data is essential for your company’s medium- and long-term planning and investment decisions.

Furthermore, if you wish to borrow money, your lender may want a cash flow statement or forecast in order to evaluate your company’s financial condition and prospects.

To learn more about the importance of cash flow in understanding your company’s financial health and managing potential risks, reach out to our team for assistance

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Thomas Howard

Business Lawyer & Consultant

At Collateral Base we help clients get organized, licensed, capitalized and exert their rights in court. We have #GoodProblems

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