How to analyse a cash flow statement

A crucial aspect of finance is the ability to analyse financial statements. It may not be a stretch to say that the statements form the bedrock of all finance. Be it researching stocks, or evaluating valuations for potential mergers and acquisitions, the financial statement reigns supreme. Of the three, income statement, balance sheet, and cash flow statement, the most important one is the cash flow. While the first two tell us about the overall growth and stability of a company, it is the cash flow that can give us some idea about future growth prospects. But often, this statement hasn’t been analysed the way it should and the numbers are taken for granted. Let’s understand how to properly analyse the cash flow statement and what valuable insights it provides us with. The cash flow statement can be divided primarily into three parts, cash flow from operations, cash from investing activity, and cash from financing activity. Let’s understand their components in detail.

Cash flow from operations

This part reflects the cash flow from operations. Profits from operations are where the money is being made from. The various components are primarily receivables, inventory, payables, loans, direct taxes, and exceptional items.
Receivables: How much is owed to the firm
Payables: How much is owed by the firm
Inventory: Unsold but completed products
These three components form an important combination which is known as working capital, i,e how much money cash is needed to run the day to day operations of the firm.

Working Capital= Receivables+Investory-Payables

A negative WC is usually a good sign as it means the company is successfully able to run its operations from money borrowed.

Capital expenditure

The crucial aspect of this category is CAPEX or capital expenditure. This is calculated through the formula: CAPEX=fixed assets purchased- fixed assets sold

This is a very important aspect to look out for. Several times a high CAPEX indicates that the company has been reinvesting their profits into fixed assets which would lead to future cash flows i.e high possibility of growth. High CAPEX for asset-heavy industries is especially a good sign. The golden number for companies though is free cash flow. Subtracting CAPEX from CFO is how we get FCF. It is chased by investors since that’s the money that can be invested towards acquisitions or providing dividends to shareholders, actions a great company takes.

Cash flow from investing

The last part is the Cash flow from Investing and it primarily comprises of cash flow from repayment of borrowings, debentures, etc. This doesn’t tell a lot like the other two parts but conveys how much dividend is being paid across to shareholders. Master the cash flow statement and you are on your way to analysing companies and businesses like never before.