In business, maintaining positive cash flow is vitally important. Cash flow refers to the movement of cash in and out of a business as it generates revenue while also covering its operating expenses. A cash flow statement is a way to summarize cash flow activity and analyze trends. Understanding how to read (or write) a cash flow statement is important for measuring the financial health of your business. And if you’re an investor, cash flow statements can offer insight into a company’s financials to help you decide whether it belongs in your portfolio.
Cash Flow Statement, Explained
A cash flow statement is essentially a snapshot of a business’s cash flow during a set time frame. This is also referred to as an accounting period. A cash flow statement lets you see at a glance how cash moves through a business.
When cash flows into a business, that means the company receives money. For example, when investors buy shares of stock in a company on an exchange, the capital that’s raised is considered an inflow.
The other side of the coin is when cash flows out of a business. For example, cash flows out when a company meets its payroll obligations for the week or month, pays its suppliers for materials or inventory or covers an outstanding tax bill.
Companies that file reports with the Securities and Exchange Commission (SEC) are required to file cash flow statements routinely. These statements are submitted along with their quarterly earnings reports and annual reports.
The Importance Cash Flow Statements
Cash flow statements are important, because they’re a way to measure a company’s financial health. Along with other financial documents, such as a profit-and-loss statement or balance sheet, can be used to gauge whether a company is meeting its financial goals, keeping its spending in check or generating enough revenue to be profitable.
As a business owner, those things are important to know when shaping your strategic plan. If you review your cash flow statement and see that your expenditures have increased sharply while your cash inflows have remained steady or declined slightly, that’s a sign that you may need to review your budget and operating model.
Cash flow statements can also be useful from an investor perspective. When comparing companies to invest in, you can focus on fundamental analysis, technical analysis or both. Fundamental analysis focuses on the company’s fundamentals, i.e. things like cash flow, revenues and the balance between assets and liabilities. If you lean more toward the fundamental analysis school of thought versus technical analysis, which looks more at price movements, then a cash flow statement could be a helpful decision-making tool when choosing where to invest.
How to Read a Cash Flow Statement
Cash flow statements can be simple or complex, depending on the nature of the business. Typically, however, you can expect to see a cash flow statement broken down into three sections detailing operating activities, investing activities and financing activities. All three portions of the statement are important for retail investors to assess.
- Operating Activities
Operating activities are the things a business does to stay in business or its purpose for existing. For example, a restaurant’s primary operating activity is serving food while a tech company’s primary operating activity may be selling software or IT services.
This section of a cash flow statement should show all the positive cash flow generated by everyday operating activities. It includes any cash flow generated after goods or services are delivered and takes into account measures for both revenue and expenses.
- Investing Activities
This section of a cash flow statement would list any flow of cash in or out of the business related to investing activities. For example, if a company were to make an investment in new equipment while selling equipment it already owns, the proceeds would be included here.
Investing activities can also span the sale or purchase or other income-producing assets. For example, if a company buys another company or franchise that produces cash flow that could be listed here.
- Financing Activities
Financing activities refers to cash flows that occur between a company and its creditors or a debtor that owes it money. Both debt and equity financing can be included here. So if a company has an outstanding business loan, the payments to that loan would be listed in this section. Or if the company is making dividend payments to shareholders that would also go here.
Having a cash flow statement broken down this way makes it easier to see which activities are generating the most positive cash flow and which ones are resulting in negative cash flows. In an ideal world, the cash flow generated from a company’s operating income would exceed its net income. When cash flow is positive that means the company is in a good financial position and can pay its obligations while also having the potential to grow.
On the other hand, negative cash flows means there’s an imbalance between what a company spends and what it takes in. Negative cash flow doesn’t necessarily mean the company is in poor financial health. For example, startups can have negative cash flow as they work on establishing themselves in their respective marketplaces. But sustained negative cash flow can hint at a deeper issue with how the company’s finances are being managed.
Cash Flow vs. Profit
It’s easy to confuse cash flow and profit, but they aren’t the same thing. Cash flow shows the movement of money in a business, while profit measures a company’s revenue after expenses are taken out.
It’s important to keep in mind that a company can be profitable, yet have limited cash. Or a business can have positive cash flow but not be profitable. For that reason, it’s helpful to look at all of company’s financials when deciding whether to invest. The same is true if you’re an entrepreneur who’s interested in buying another business.
And if you want to write your own cash flow statement for a business you own, it’s fairly easy to do. Accounting software programs can generate a cash flow statement for you based on the numbers you input. But if you want to create a cash flow statement, you can do that by:
- Choosing a time period to measure
- Tallying the amount of cash your business has on hand at the beginning of that time period
- Calculating the cash coming in for that time period
- Calculating the cash going out for that time period
- Adding the cash coming into your initial cash balance, then subtracting your cash outflows from the total
This is a very simplified method, but it can help you quickly see what’s happening with cash flows in your business.
The Bottom Line
Cash flow statements, along with other financial statements, can be a useful way to get a feel for how a company is doing financially. If you run a business, it’s helpful to run cash flow statements regularly to track your progress and look for areas where you may need to adjust spending. If you’re an investor, you can use cash flow statements as a guidance tool when selecting companies to invest in.
Tips for Investing
- Consider talking to a financial advisor about how to create a cash flow statement if you run a business. If you don’t have an advisor yet, finding one doesn’t have to be difficult. SmartAsset’s financial advisor matching tool can help. By answering a few simple questions online you can get personalized recommendations for advisors in your local area. If you’re ready, get started now.
- Besides a cash flow statements, investors should analyze a company’s income statements and its balance sheet. An income statement shows revenues and expenses over a period of time. A balance sheet looks at assets and liabilities at a specific point in time.
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