Why You Should Care About the Cash Flow Statement

By: Lianabel Oliver

If you are a manager, business owner, or entrepreneur, you have probably seen a statement of cash flows for your company, a customer, or a vendor. How many of you have used it to evaluate how well your company is performing, or whether you should extend credit to a customer, or do business with a vendor?

When managers analyze financial statements, they tend to focus primarily on the income statement. This statement shows the magical bottom-line known as net income. We assume that if a company has net income, it is doing well, and has the cash to pay for recurring operating expenses and meet commitments with its customers and suppliers. However, in most companies, net income is not equal to cash, nor does it reflect the cash position of the company.

The statement of cash flows presents a summary of all transactions that affected cash for a particular accounting period. It details the sources and uses of cash and shows you how the cash position of a company changed from one accounting period to another. It is particularly useful when you want to evaluate the payment capabilities of your customers or the financial capacity of your vendors to meet their commitments.

The cash flow statement is divided into three major sections: operating activities, investing activities, and financing activities. You can answer key questions on a company’s cash position by simply focusing on the subtotals for each major section in this statement.

Operating Activities: Is the company generating cash from its primary business activities?

The operating activities section provides you with an indication of how much cash the company is generating from its primary business operations — usually the sale of products and services. If the subtotal in this section is too low or negative, it means that the company is not generating enough cash through its main business activities — definitely a red flag! A cash flow deficit from operating activities will have to be compensated using financing or investing activities, or by using cash reserves from prior periods.

Investing Activities: How is the company using its excess cash? Is it selling assets to compensate for a cash flow deficit from its operating activities?

This section shows the cash generated from investing activities. Investing activities include all activities in which the company has expended cash with the expectation of generating an additional income or profit for the company. It includes activities such as lending money, collecting on loans, acquiring and selling marketable securities, and acquiring and selling land, buildings, or equipment. If the subtotal in this section is negative, it means that the company used cash to purchase investments; if it is positive it means that the company sold investments to provide an inflow of cash. If the company is selling its assets, it could be an indication of a cash flow problem.

Financing Activities: How is the company financing its operations?

This section shows the cash generated from financing activities. Financing activities include transactions related to obtaining internal or external sources of funds. In this section, you will find the cash inflows from the proceeds of stock and debt issues, and the cash outflows from the repurchase of stock, the repayment of loans, and dividend payments, among others. If the subtotal of this section is positive, it usually indicates that the company raised cash through the issuance of debt or stock; if it is negative, it may mean that the company used its cash to payoff its debt, repurchase stock, or pay dividends.

So next time you see a statement of cash flows, don’t ignore it. It is not as complex as you think. Take a close look at the subtotals in each major section and understand how the company is generating and using its cash.

What you find out may surprise you!


Why You Should Care About the Cash Flow Statement