Cash Flow Analysis

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What is a Cash Flow Analysis?

The cash flow analysis refers to the examination or analysis of the different inflows of the cash to the company and the outflow of the cash from the company during the period under consideration from the different activities, which include operating activities, investing activities, and financing activities.

IronMount Corp and BronzeMetal Corp (both hypothetical companies) had identical cash positions at the beginning and end of 2007. Each company also reported a net income of $225,000 for 2007. Which company is displaying elements of cash flow stress? What factors cause you to reach this conclusion?

Let’s say Company ABC has just started a business and earned revenue of $100 this year. And as per the record, their expenses are $60. Now in general terms, you would say Company ABC has made a = $(100 – 60) = $40 profit. However, in the case of Company ABC, it’s seen that they have a revenue of $100 this year, but they have collected only $80 this year, and the remaining they will collect in the next year. In the case of expenses, they have only paid the US $50 this year and the remaining in the next year. So if we calculate the net cash inflow this year, it would be $(80 – 50) = $30.

So, even if Company ABC has made a profit of $40 this year, its net cash inflow is $30.

In Cash Flow Analysis, we will include the cash related to operations and expenses and incomes from investing and financing activities.

Cash Flow Analysis

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Source: Cash Flow Analysis (wallstreetmojo.com)

Step by Step Cash Flow Statements Analysis

Cash Flow Analysis is divided into three parts – Cash flow from Operations, Cash flow from Investments, and Cash flow from financing. We discuss each of these by one.

Cash Flow Analysis - Diagram

#1 – Cash flow from Operations

Cash flow from the operation means accounting for cash inflows generated from the normal business operations and their corresponding cash outflows.

There are two ways to calculate cash flow from operations – 1) the Direct and 2) the Indirect method.

The indirect method is used in most cases.

Here we will look at only the indirect method for computing cash flow from Operations.

Computation of Cash Flow from Operations:

Learn Cash Flow from Operations in detail – Cash Flow from OperationsCash Flow From OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more

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Colgate’s Cash Flow from Operation Example

Cash Flow Analysis - Operating Activities

source: Colgate SEC Filings

  • Even though Colgate’s Net Income in 2015 was $1,548 million, its cash flow from Operations seems to be in line with the past.
  •  If you look closely at the 2015 Cash Flow from operations, there is a charge for Venezuela’s accounting change that has contributed $1,084 million in 2015. It was absent in 2013 and 2014. If you remove this charge, Colgate’s Cash Flow From Operations will not look too exciting.

#2 – Cash Flow from Investment Activities

Other than operations, the company also invests in assets that can provide them with greater returns. Cash Inflow from investing activities would include purchasing long-term assets or securities or selling them (except cash) and providing and taking loans. We need to find out how many cashless (loss or gain) activities are done during the period so we can take them into account while ascertaining the net cash inflow.

Though there is not much to be talked about here, two things should be taken into account.

Learn Cash Flow from Investments in detail – Cash flow from InvestmentsCash Flow From InvestmentsCash flow from investing activities refer to the money acquired or spent on the purchase or disposal of the fixed assets (both tangible and intangible) for the business purpose. For instance, the purchase of land and joint venture investment is cash outflow, while equipment sale is a cash inflow.read more

Colgate’s Cash Flow from Investment Example

Cash Flow Analysis - Investing Activities

source: Colgate SEC Filings

  • Colgate’s Cash Flow Analysis from Investing Activities was at -685 million in 2015 and -859 million in 2014.
  • Colgate’s core capital outlay was -691 million in 2015 as compared to -757 million in 2014.
  • In 2015, Colgate got proceeds of $599 million from the sale of marketable securities and investments.
  • Additionally, Colgate received $221 million from selling the South Pacific laundry detergent business.

#3 – Cash Flow from Financing Activities

Colgate’s Cash Flow from Financing Example

Cash Flow Analysis - Financing Activities

source: Colgate SEC Filings

Learn Cash Flow from Financing Activities in detail – Cash Flow from Financing ActivitiesCash Flow From Financing ActivitiesCash flow from financing activities refers to inflow and the outflow of cash from the financing activities like change in capital from securities like equity or preference shares, issuing debt, debentures or repayment of a debt, payment of dividend or interest on securities.read more

Cash Flow Analysis Example – IronMount vs. BronzeMetal

Let’s go back to the earlier cash flow analysis example that we started with – IronMount Corp and BronzeMetal Corp had identical cash positions at the beginning and end of 2007. Each company also reported a net income of $225,000 for 2007.

Perform its Cash Flow Analysis.

Cash Flow Analysis

IronMount and Bronze Medal, both companies, have the same end-of-the-year cash of $365,900. Additionally, changes in cash during the year are the same at $315,900. Which company is displaying elements of cash flow stress?

Cash Flow Analysis Example – Alphabet (Google)

Cash-Flow-Analysis-Alphabet

source: ycharts

Cash Flow Analysis Example – Amazon

Cash-Flow-Analysis-Amazon

source: ycharts

Cash Flow Analysis Example – Box Inc

Cash-Flow-Analysis-Box

source: ycharts

Limitations

Even if cash flow analysis is one of the best tools for investors to find out whether a company is doing well, cash flow analysis also has a few disadvantages. We will have a look at them one by one.

  • One of the most significant things about cash flow analysis is that it doesn’t consider any growth in the cash flow statement. The cash flow statement always shows what happened in the past. But past information may not be able to portray the right information about a company for investors interested in investing in the company. For example, if the company has invested a large amount of cash into R&D and would generate a huge amount of cash through its ground-breaking idea, these should come in the cash flow statement (but they don’t get included in the cash flow).
  • Another disadvantage of the cash flow statement is this – it can’t be easily interpreted. For example, it’s difficult to understand from a cash flow statement whether a company is paying off its debt or investing more in assets. If you ask any investor to interpret the cash flow statementCash Flow StatementA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.read more, he wouldn’t be able to understand much without the help of the income statement and the other information about transactions that occurred throughout the period.
  • A Cash Flow Statement is inappropriate if you want to understand the firm’s profitability because, in the cash flow statement, non-cash items are not considered. Thus, all the profits are deducted, and all the losses are added back to get the actual cash inflow or outflow.
  • The Cash Flow Statement is articulated based on the cash basis of accounting and completely ignores the accrual concept of accounting.

Summary

Line ItemComments
Cash flow from operating activities 
Net IncomeFrom the Net Income line on the income statement
Adjustments for 
DepreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more & AmortizationFrom the corresponding line item in the Income Statement
Provision for losses on accounts receivablesAccounts ReceivablesAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read moreFrom the change in the allowance for doubtful accountsAllowance For Doubtful AccountsAllowance for doubtful accounts primarily means creating an allowance for the estimated part that may be uncollectible and may become bad debt and is shown as a contra asset account that reduces the gross receivables on the balance sheet to reflect the net amount expected to be paid.read more in the period
Gains / Loss on sale of a facilityFrom gain/loss accounts in the Income Statement
Increase/Decrease in trade receivablesChange in trade receivablesTrade ReceivablesTrade receivable is the amount owed to the business or company by its customers. It is also known as account receivables and is represented as current liabilities in balance sheet.read more during the period from the balance sheet
Increase/Decrease in inventoriesChange in inventory during the period from the balance sheetThe Period From The Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more
Increase/Decrease in trade payablesChange in trade payable during the period from the balance sheet
Cash generated from OperationsSummary of preceding items in the Section
  
Cash Flow from Investing Activities 
Purchase of Fixed AssetsItemized in the fixed asset accountsAsset AccountsAsset Accounts are one of the categories in the General Ledger Accounts holding all the credit & debit details of a Company’s assets. The examples include Short-Term Investments, Prepaid Expenses, Supplies, Land, equipment, furniture & fixtures etc. read more during the period
Proceeds from the sale of Fixed AssetsItemized in the fixed asset accounts during the period
Net Cash Used in Investing ActivitiesSummary of preceding items in the Section
  
Cash Flow from Financing Activities 
Proceed from the issuance of common stockNet Increase in Common Stock & additional paid-in Capital accountsAdditional Paid-in Capital AccountsAdditional paid-in capital or capital surplus is the company's excess amount received over and above the par value of shares from the investors during an IPO. It is the profit a company gets when it issues the stock for the first time in the open market.read more during the period
Proceeds from issuance of Long Term DebtIssuance Of Long Term DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company's balance sheet as the non-current liability.read moreItemized in the Long Term Debt accounts during the period
Dividends PaidItemized in the Retained Earnings accounts during the period
Net Cash Used in Financing ActivitiesSummary of preceding items in the Section
  
Net Change in Cash & Cash EquivalentsSummary of All the Preceding Subtotals

Conclusion

To understand a company and its financial affairs, you need to look at all three statements and all the ratios. Only cash flow analysis would not be able to give you the right picture of a company. Look for net cash inflow, but also ensure you have checked how profitable the company has been over the years.

Also, cash flow analysis is not an easy thing to calculate. If you want to calculate cash flow analysis, you need to understand more than the basic level of finance. And you also need to understand financial terms, how they are captured in the statements, and how they reflect the income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more. Thus, if you want to do a cash flow analysis, first know how to see the income statement and understand what to include and what to exclude in the cash flow statement.

Cash Flow Analysis Video

 

Reader Interactions

Comments

  1. Aziz Ur Rahman says

    Thank you for such professionally excellent analysis of cash flow

    • Dheeraj Vaidya says

      thanks Aziz!