Understanding cash flow statement

The cash flow statement (CFS) forms part of a company's annual report. It is a summary of receipts and payments disclosing the movement of cash during a specific period. The CFS reflects the liquidity and solvency position of a company. It throws light on the ability of the company to generate cash from its core operations, and where from it sources funds for expansion. It is also a useful tool to gauge a company's ability to effectively manage cash. While profit figures by itself may not help the company plan for repayment of debt and replacement of assets, an analysis of the cash flows will provide information on funds available for this.

Operating activities

Cash flows are classified under three heads — operating, investing and financing activities. Cash sales, receipts from debtors, payment to suppliers, selling and distribution of expenses, all fall under operating activities.

Actual cash flows differ from profits. A company may be low on cash but report good earnings and vice-versa. The CFS explains the reason for this divergence. Consider this. A company that has sold its goods on credit (captured as debtors) may take time or have trouble realising the cash. This may elongate the company's working capital cycle and force it to resort to other funding options to keep the production cycle moving. Similarly, a company may have produced goods but piled them up as inventory without quickly converting them into revenues. Here again the cost of holding such inventory would affect operations. Thus, a study of operating cash flows may be a key indicator of a company's health or provide cues for impending trouble.

Investing and financing

While purchase and sale of fixed assets, investments, interest income/dividend received are examples of cash flows from investing activities, receipts from the issue of shares and debentures, repayment of loans, payment of dividends fall under financial activities. These are disclosed under separate heads in the CFS. Investing activities indicate the extent to which a company has spent on resources that generate future income and cash flows. Flows from financing activities indicate the various avenues from which a company's funds are sourced and the debt servicing and repayments made to such sources.

Negative cash flows

Theoretically, positive operating cash flows are considered an indicator of efficiency. But does that mean that operating cash flows should not be negative? This is typical of companies in the growth phase which raise money to expand operations and generate future cash flows (after a lag) whether directly or through subsidiaries.

Negative cash flow in one year should not be immediately misconstrued for trouble. An analysis of cash flows from one period to another may provide a better picture. Negative cash flows from investing could suggest that the company is incurring capital expenditure, which would generate income in future. When a company is repaying debt or buying back shares or paying dividends, cash from financing operations tends to be negative. However, in this case, there is often sufficient cash generated from operations to make the above-stated payments.



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