What is Cash Flow from Financing Activities?
Cash flow from financing activities refers to inflow and the outflow of cash from the financing activities of the company like change in capital from the issuance of securities like equity share, preference shares, issuing debt, debentures and from the redemption of securities or repayment of a long term or short term debt, payment of dividend or interest on securities.
It is the last of the three parts of the cash flow statement that shows the cash inflows and outflows from finance in an accounting year; Financing activities include cash inflows that are generated from getting funds like inflows from receipts from the issue of shares, receipts from a loan taken, etc. and cash outflows that are incurred while repaying such funds such as redemption of securities, payment of dividend, loan & interest repayment, etc.
In a nutshell, we can say that cash flow from financing activities reports the issuance and repurchase of the company’s bonds and stock and the payment of dividends. It reports the capital structure transactions. Items are found in the long-term capital section of the balance sheet and the statement of retained earnings.
List of Items included in Cash Flow from Financing Activities
Common items included in the cash flow from Financing activities are as follows –
- Cash dividend paid (cash outflow)
- Increases in short-term borrowings (cash inflows)
- The decrease in short-term borrowings (cash outflow)
- Long-term borrowings (cash inflows)
- Repayment of long-term borrowings (cash outflow)
- Share sales (cash inflows)
- Share repurchases (cash outflow)
It is of the view for many investors that cash at the end of the king.
If a company has surplus cash, then it can be assumed that the company is operating in the so-called safe zone. If a company is consistently generating more cash than the cash used, it will come out in the form of dividend payments, share buybacks, reduction in debt, or case of acquisition to grow the company inorganically. All of these are perceived as good points to create good stockholder value.
Let us have a look at how this section of the cash flow statement is prepared. Understanding the preparation method will help us evaluate what all and were all to look into so that one can read the fine prints in this section.
How to Calculate Cash flow from Financing Activities?
Let’s assume that Mr. X starts a new business and has planned that at the end of the month, he will prepare his financial statements like income statement, balance sheet, and cash-flow statement.
1st month: There was no revenue in the first month and no such operating expense; hence income statement will result in net income to be zero. In cash flow from financing activities, the cash would increase by $2000, as that is Mr. X’s investment in the business.
|Cash from Financing activities (end of the first month)|
|Investment by Mr. X (Owner)||$ 2,000|
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Cash flow from Financing Activities Example
Let’s take an example to calculate Cash Flow from Financing activities when Balance Sheet Items are provided.
Below is a balance sheet of an XYZ company with 2006 and 2007 data.
Also, assume that the Common dividends declared – $17,000
Calculate Cash Flow from Financing.
To prepare the cash flow from Financing, we need to look at the Balance Sheet items that include the Debt and Equity. Besides, we also need to include the cash dividends paid as cash outflows here.
- Bonds – the company raises bonds and results in the cash inflow of $40,000 – $30,000 = $10,000
- Common Stock – Change in common stock balance = $80,000 – $100,000 = – $20,000
- Please do note that we do not make the changes in retained earnings as retained earning is linked to the Net Income from the income statement. It is not a part of financing activities.
- Cash Dividends Paid = – Dividends + increase in dividends payable = -17,000 + $10,000 = -$7,000
Cash Flow from Financing Activities Formula = $10,000 – $20,000 – $7,000 = $17,000
Now let us take an example of an organization and see how detailed cash flow from financing activities can help us in determining information about the company.
source: Apple 10K
This article is another major component of cash spending, and investor looks at it in details. It is indicative of the kind of financing activity which has been undertaken by the company in a particular area. In FY15, Apple incorporation spent $20,484 million in financing activities. Few observations from the above cash flow from financing activity parts are:
- The company has been a steady dividend payer. In the last three years company has been paying a dividend of over $11000 million each year. Investors who don’t wait for capital appreciation can earn money from the steady dividend paid by the company every year.
- One more important factor to see is the repurchase of shares. The repurchasing of shares is indicative of the fact that the company has been generating steady returns. The company is generating ample cash and is using the same to buy-back stocks. The average repurchase amount over the last 3 years has been well over $35,000 million.
- The third most interesting thing one can see from the above statement is that the company has been taking long-term debts. This might be one of the ways the company is financing its activities. However, as an Apple incorporation, which is overall sitting on a pile of cash, it would be interesting to question why such an entity will take in more long-term debt. It can be either a business decision, or is it because of the fact that borrowing rates have been at an all-time low, and the cost of financing through equity is not feasible. Also, note that the company, on the one hand, is repurchasing shares, and hence taking more money from the equity market can be counterproductive.
Let’s now have a look at another company’s cash flow from operations and see what it speaks about the company. This is the case of an e-commerce venture Amazon Inc. The company for years didn’t generate accounting profit, but investors kept putting money into the company on the backdrop of the sound business proposition and huge cash generated from operations.
source: Amazon 10K
The above image is a historical representation of the cash flow from financing activities of Amazon. We note the following about Amazon’s Cash Flow from Financing activities calculations –
- Cash outflows were majorly related to repayments of long-term debt, capital lease obligation, and financial lease obligation
- Proceeds from Long-term financing has continuously been positive and very high. This is indicative of the fact that the company has continuously been borrowing long-term debt.
- Repayments of long-term financing show a huge cash outflow. This is indicative of the fact that the company has been extensively paying off its long term debt. If we see the two in conjunction, one can see that the company has been taking a constant long term debt position and is paying the equal amount back to banks as part of its debt-repayment schedule (in 2014). Investors can explore this option in more detail to see whether the company is financing its debt by taking more debt.
JPMorgan Bank Example
Till now we have seen one product and one Service Company. Now let us have a look at one of the banking majors. This will give us good coverage of how companies classify different functions under ‘cash flow from financing activities.’
source: JPMorgan 10K
Since this entity is a bank, a lot of line items will be completely different from what it is for others. There are many line items that are only applicable to banks or companies in financial services. Few observations from the above statements are:
- The bank has been buying lots of federal funds for the last three years. This is more because of how the economy is shaping up. The government is mopping up funds and issuing fresh debt in the market. This debt is being picked up by banks, and hence fund outflow as lots of federal funds are being purchased.
- The quantum of the dividend has been steadily increasing over the last 5 years. This is indicative of the fact that banks are now out of turmoil, which they faced in 2008-2009. The economy has definitely turned a circle, and banks are able to pay out steady dividends.
What Analyst should know?
Till now, we have seen three different companies in three different industries and how cash means different for them.
For a product company, cash is the king. For the service company, it is a way to run a business, and for a bank, it is all about cash!
These three companies have different things to offer in the cash flow from financing activities part of the cash flow statement. However, it is crucial and imperative to understand the statement should not be singled out and seen. They should always be seen in conjuncture and a combination of other statements and management discussion & analysis.
Also, note that cash flow for financing trends could be identified and extrapolated to estimate the funding requirements of the company in the future (also look at – how to forecast financial statements?)
Investors earlier use to look into the income statement and balance sheet for clues about the situation of the company. However, over the years, investors have now also started looking at each one of these statements alongside the conjunction of cash flow statements. This actually helps in getting the whole picture and also helps in taking a much more calculated investment decision. As we have seen throughout the article, we are able to see that cash flow from financing activities is a great indicator of the core financing activity of the company.
If the company has surplus cash, then it can be assumed that the company is operating in the so-called safe zone. If a company is consistently generating more cash than the cash used, it will come out in the form of dividend payments, share buybacks, reduction in debt, or case of acquisition to grow the company inorganically. All of these are perceived as good points to create good stockholder value.
Cash Flow from Financing Activities Video
This has been a guide to Cash Flow from Financing Activities, formula, and its calculations. Here we also discuss cash flow from financing activities examples of Apple, JPMorgan, and Amazon.