The cash flow statement shows all the cash inflows and outflows occurred during the reporting period.
Cash flow analysis is a critical part of any investment decision as it is influenced less by accounting practices.
On the income statement, a transaction is recognized when the earnings process is completed. This does not necessarily coincide with the time that cash is exchanged.
Cashflows are classified by business activities:
Cash flow from (used for) operating activities
Operating activities represent the company’s primary business activities and reflect the cash effects of transactions which are included in the determination of net income.
To calculate operating cash flow (OCF), we take the net income for a given period and add non-cash expenses +/- changes in working capital.
So let’s look at the key components of cash flow from operating activities:
- Net earnings (net income): All revenues minus all the expenses incurred. This is the profit (or loss) for the accounting period.
- Adjustments to reconcile net earnings to net cash from operating activities: In this segment, the net income is adjusted for all non-cash items that have been added or deducted to calculate net income. Such non-cash items include depreciation and amortization, depletion, deferred taxes, changes in working capital, etc…Net income is an accounting figure. Therefore to determine the impact on the cash levels of the business, we need to adjust the net income for non-cash accounting charges.Operating cash flow (OCF) = Net income + depreciation, amortization, depletion, deferred taxes, etc… + changes in working capital.
- Operating cash flow: Operating cash flow shows the amount of cash generated by a company’s primary business operations. Operating cash flow is also used to determine “free cash flow”, which is an important figure in calculating the future earnings of the business.
Cash flow from (used for) investing activities:
This section includes the amounts of cash generated by or used for investing activities.
Let’s look at some important examples of investing activities:
- Securities purchases: Securities bought by the company as an investment. These are bought because it generates extra cash for the company while they remain highly liquid.
- Principal payment received on securities: Interest payments received on security investments.
- Purchase of fixed assets: Often referred to as “Property, plant, and equipment”. This line item includes the amounts spent on maintenance (CAPEX) and investment in long term assets such as machinery, buildings, trucks, land, etc.
- Net cash flow used for investing activities: The difference between all the cash inflows and outflows for investing purposes.
Cash flow from (used for) financing activities
Flows of cash used to fund the company. These can include debt, dividend, and equity transactions.
Let’s look at some common examples:
- Net cash flows provided by (used for) financing activities: The amounts used for paying down debt, stock repurchases and paying dividends would cause a negative cash flow. Issuing stock or borrowing debt would cause a positive cash flow.
- Effect of exchange rate changes on cash flows: Companies with foreign operations report the effect of currency exchange rates on their cash position.
Increase in cash flows
Difference between the cash balance at the beginning of the year and at the end of the year.
Cash and cash equivalents at beginning of year
Prior year, end of year balance.
Cash and cash equivalents at the end of year
Current year, end of year balance. If the balance decreases, that means the company used more money than it has generated.