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.