Envision a company, perhaps an extremely successful and stable business. In your opinion, what sorts of operations would characterize a typical textile firm?
- Advertising space dedicated to luring in new customers through visuals.
- Employ people to assist clients.
- Obtain a short-term bank loan Raise capital for growth by issuing new shares to a select group of investors.
- Invest in a new company developing a new line.
- Putting any extra cash into fixed deposits.
- Putting money into an upgrade with the intention of spreading business further.
The aforementioned items are quite varied, but they all pertain to the company and can be categorized as such:
Operational activities (OA) entail doing things that keep the wheels of the business turning on a daily basis. Operating activities include but are not limited to, selling products, buying raw materials, displaying advertisements, employing workers, etc., as demonstrated above.
Investing activities (IA) are those that involve the company making investments with the hope of future financial gain. Putting money in a savings account, buying a house, opening a business, etc.
Financing activities (FA) When a company issues shares, borrow money, or pays out dividends, these are all examples of financing activities (FA).
The cash flow statement is where you can find out how much money has come in and how much money has gone out of a business.
A cash flow statement is a type of financial statement that summarizes the cash flows into and out of an organization over a specified time period. This statement, as its name implies, details the movement of money throughout the various operations of a business.
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What is the point in looking at the Cash Flow statement?
Even if you have your P&L statement, the cash flow statement is still important. Unlike the cash flow statement, which details the actual inflow and outflow of cash for a given period, the profit and loss statement primarily deals with revenue and expenses, which may not necessarily represent actual cash transactions. The flow of money from source to sink is laid bare for inspection.
Let’s dive into the specifics of the Cash Flow Statement’s various Cash Flow entries.
1. Business Operations:
Insights into a company’s ability to generate cash flow from its core business operations are greatly enhanced by this metric. Expenditures and receipts that arise from running the business properly make up this part of the cash flow statement.
Cash Flows from Operations consist of all money coming in and going out of the business. This section of the cash flow statement now accurately reflects the total net result from all operating activities.
If a business is able to generate cash from its operations, this is a good indicator that its operations can be sustained. Companies with positive operating cash flows are the ones we should be targeting.
A company with a negative operating cash flow is likely experiencing cash flow issues or operational difficulties because it is spending more money than it is bringing in.
2. Speculative Actions:
The cash flow statement’s section titled “Investing Activities” sheds light on the company’s spending on long-term assets and non-operating investments. It reflects cash inflows and outflows caused by the purchase and sale of investments and other long-term assets. The acquisition of fixed assets, stock in another company, etc., are all possible examples.
A cash flow statement that shows a positive investing cash flow indicates that the company is selling assets and investments. The company may be selling off assets, reducing expenses, or refocusing on its core competencies. However, if the ongoing investment is not sustainable, it may also indicate financial strain.
When a company’s cash flow statement shows a negative amount for investing cash flow, it means that it is investing in long-term assets like property, equipment, or financial instruments. Growth, expansion, and a focus on creating value over the long term are all positive signs. We need to find businesses that have investing cash flows in the negative.
3. Financial dealings:
It reveals information about the sources and uses of a company’s financing. The capital structure of a company, including its debt and equity financing, affects the company’s cash flow.
A cash flow statement showing a negative financing cash flow indicates that the company is paying back more debt or equity financing than it is bringing in. It could mean that the company is having trouble attracting financing or paying off its existing debt, or it could mean that it is returning value to its shareholders.
An increase in financing cash flow over debt or equity repayments indicates that the company is generating more cash than it is spending. It indicates financial strength and capacity to support growth and meet obligations, such as capital infusions for expansion, dividends, or debt refinancing. Here, we have to consider whether or not the funds came from debt or equity.
Now that we’ve gotten to the essence of the discussion, it’s important to keep in mind that a company’s cash flow should be positive from operating activities, negative from investing activities, and positive from financing activities only under very close scrutiny because positive cash flows from investing activities can arise from the sale of the company’s assets.