Interpreting the cash flow statement involves understanding the sources and uses of cash from different activities of a company. You do not need to be a CFO to gain valuable insight from this report. By asking yourself basic questions and checking the report, the data will inform you of critical business changes and improve your decisions.
Interpreting Cash from Operating Activities
This section represents cash flows from the company’s core business operations, including revenue generation, expenses, and working capital changes. Questions to ask when analyzing cash from operations includes:
- Is the net cash provided by operating activities positive or negative? How does it compare to previous periods?
- Is cash from operations generated by one-time occurrences, such as a large invoice payment, or by systemic processes, such as overall business growth?
- Are the cash flows from operations sustainable? Are there any signs of improving or deteriorating cash generation?
Bootstrapping businesses demand positive cash from operations to sustain themselves and fund their growth. On the other hand, venture capital backed businesses expect negative cash from operations since they have external financing and prioritize growth over profitability.
Interpreting Cash from Investing Activities
This section captures cash flows from investments in long-term assets, acquisitions, and divestitures. Questions to ask when looking at the investing activities include:
- Are there consistent investments in fixed assets which indicate the company is planning growth?
- Are there major one-time investments in fixed assets, intellectual property, or other investments?
Having positive cash from investing activities, though common with large public corporations, is unusual for small businesses. Instead, small businesses should expect negative cash from investing activities. This signifies that a company is making investments in growth opportunities, such as acquiring new assets, expanding operations, or investing in research and development, which can lead to future profitability and value creation.
Interpreting Cash from Financing Activities
This section shows cash flows related to the company’s capital structure, such as equity or debt issuances, dividends, or repurchases of shares. Questions to ask when analyzing cash from financing activities include:
- Does cash from operations sufficiently cover debt service obligations?
- Are there any upcoming maturities or covenants that may impact cash flow?
- What are the interest rates and terms of the various debt instruments?
- Is the company returning cash to stakeholders or is it receiving outside investment to fuel growth and/or losses?
- How do the financing activities affect key financial ratios such as the debt-to-equity ratio, interest coverage ratio, or other leverage metrics?
Having positive cash from financing activities is generally considered good as it indicates that a company is raising capital through sources like issuing stocks or bonds, securing loans, or receiving investments, which can support its growth, expansion, and financial stability. Modest negative cash from financing can be good if it signifies that a company is repaying debts or returning capital to shareholders, indicating a healthy financial position and reduced reliance on external financing. On the other hand, rapid repayment of loans or dividends can deplete a company’s cash and trigger a liquidity crisis, so cash from financing should never be excessively negative.
Interpreting all financial statements
The statement of cash flows is just one of three critical financial reports – the others being the balance sheet and the income statement. Once you understand each of these reports individually, check out our guide on the interpreting the income statement and cash flows together to develop powerful analytic skills and business judgement.