Your business needs to consider three important financial statements: a profit and loss statement, balance sheet, and cashflow statement.
The cashflow statement tracks how cash moves in and out of the business during a specific time period. Prepared by the company’s controller or business accountant, the cashflow statement should be examined regularly by the business owner or management teams.
Cashflow statements typically have three main sections: Operating Activities, Investing Activities, and Financing Activities.
How to Read a Cash Flow Statement
Step 1: Identify the Period Covered – Start by noting the period (usually quarterly or annually) for which the cash flow statement is prepared. This helps contextualize the financial data.
Step 2: Analyze Operating Activities – Review the operating activities section first. Negative numbers represent when cash was used.
Step 3: Evaluate Investing and Financing Activities – Examine the investing and financing sections next. Note significant transactions like asset purchases, loan repayments, or stock issuances.
Step 4: Analyze the Net Cash Flow – Compare the ending cash balance with the beginning balance. This calculation helps understand whether cash increased or decreased during the period.
Step 5: Interpret the Overall Cash Position – Summarize the net cash flow from all activities (Operating + Investing + Financing). Assess whether the company is generating or using cash during the period. Look at the ending cash balance to understand the overall liquidity position.
Step 6: Compare with Other Financial Statements – Cross-reference the cash flow statement with the income statement and balance sheet. Ensure consistency among the financial statements to gain a comprehensive view of the company’s financial health.
Step 7: Look for Trends and Patterns – Analyze changes in cash flow over multiple periods. Identify trends in operating, investing, and financing activities. Evaluate the company’s ability to generate sustainable cash flows. Use these key ratios and metrics to support your analysis.
- Operating Cash Flow (OCF) Ratio: OCF divided by net sales, indicating the percentage of sales converted into cash.
- Free Cash Flow (FCF): Operating cash flow minus capital expenditures, representing cash available for distribution to shareholders or reinvestment.
- Cash Flow to Debt Ratio: Operating cash flow divided by total debt, showing a company’s ability to cover debt obligations.