How does a cash flow statement work? How do cash balance and cash flow relate to each other? What is cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities?
The cash flow statement is one of the three main financial statements.
As the cash flow statement explains how much cash has come in and gone out during a year, and what the sources and uses of this cash flow were, you will be able to see the cash flow statement as an explanation of how the cash balance (one of the most important assets) has developed.
Cash is king. It is critical at every stage of a company’s lifecycle. When you open your own business, you need cash to get started. You will need cash to grow and expand. If a company runs out of cash to pay its bills, it’s over.
What you see in a cash flow statement should be a direct reflection of a company’s strategy. Is the company spending enough to build its unique and sustainable competitive advantage? Are customers willing to pay for the products and services that the company supplies? Is the company able to reward its investors for the risk they have taken, by paying a dividend? These and other questions can be answered by analyzing a cash flow statement.
Let’s take an example of a cash flow statement, more specifically the one reported by Adenike Limited in its fourth quarter 2016 earnings release. Adenike Ltd cash balance at the end of 2012 was
N18million. At the end of 2013, the cash balance was N9million. The cash flow during 2013 was therefore a negative N9million, as the cash balance has decreased versus the prior year end.
At the end of 2014, the cash balance was
N21million. The cash flow during 2014 was therefore a positive N11million, as the cash balance increased. At the end of 2015, the cash balance was N31million, due to a positive cash flow during the year of N10million. At the end of 2016, the cash balance was N19million, due to a net cash outflow during the year of N12million.
It’s nice to have the total numbers of the cash balance as well as the total net cash flow, but it doesn’t tell us much yet about what goes on inside the company. To get a more meaningful look, we have to look deeper into cash flow. That’s why a cash flow statement is split into three sections.
The first section will have the word “Operating” in it, the second “Investing”, the third “Financing”.
Many companies will call the first section Cash From Operating Activities. Cash from Operating Activities is roughly the cash inflow from customers paying the company minus the cash outflow of the company paying for purchases from suppliers, minus the cash outflow of salaries paid to employees, and minus the cash outflow of taxes paid to governments.
The second section is often called Cash From Investing Activities. This is where Capital Expenditures (a cash outflow), acquisitions (a cash outflow), and divestments (a cash inflow) are recorded. Cash From Investing Activities tends to be a net cash outflow for most companies in most years.
The third section is often called Cash From Financing Activities. This one can be either a net cash inflow or a net cash outflow. Does the company need money and attract new debt to finance itself? Then there will be a cash inflow. Does the company have a lot of cash on its balance sheet and no plans to put that cash to any productive use? Then the company might be paying a dividend to shareholders, which is a cash outflow.
The Cashflow statement is a very important tool used by businesses to measure the most important asset in the business. CASH!