Cash flow analysis. What aspects are worth paying attention to?

In addition to the balance sheet and profit and loss account analysis, an interesting financial document worth checking is the cash flow statement. It is very helpful in obtaining information on financing investment projects, assessing the profitability of the company and possible problems that occur in it. These are not all of its advantages. Therefore, today I will present you briefly how to make a simple and effective analysis of the cash flow statement and what conclusions to draw from it.

Characteristic

The cash flow statement shows us the cash inflows and outflows in the audited company. This is one of the financial documents that the company makes available to the public (we are talking about listed companies). The statement of cash flows is influenced by three types of activities, which we will discuss in detail later in the text.

In fact, the most important item in companies' financial statements is net profit. This is the actual amount that the enterprise gained in a given year. Of course, the greater the dynamics of change (increasing from year to year), the better for the company. We calculate the net profit from the profit and loss account. Honestly, it is only an accounting measure. Due to the different methods of valuation and the methodology of accounting for economic operations, it does not present real cash inflows and outflows. Therefore, a document has been developed to reflect them. This is how the cash flow statement was created.

Activities

The advantage of evaluating a cash flow analysis is that it is more difficult to manipulate cash flow (sum of cash flows) than net profit. In my opinion, cash flow serves as a much better indicator of the company's potential than the balance sheet result - net profit. It is worth noting that before approaching the analysis of this financial document, it is necessary to think and take into account the industry and specificity of the enterprisewe are researching. We should evaluate her capital intensity or lending opportunities (liquidity analysis).

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The cash flow statement shows the cash flows in three specific areas of the company's operations. Belong to them operating, investment and financial flows. When examining operating inflows / outflows, we focus on monitoring the company's current operations. They provide us with information on whether the company is generating cash. The second type of activity - investment, presents data on potential investments. Financial, on the other hand, is about whether the enterprise obtains cash by incurring liabilities.

The areas of the company's activity

Focusing on the analysis, we will use two symbols, plus and minus. We will take each type of activity into account and the flow (positive or negative), which we will replace with a symbol instead of a number. At this stage, the values ​​are not that important yet. What will the individual symbols mean, taking into account the company's areas of activity?

● operating activities
+ generates cash from business activities
- incurs losses from its core business

● investment activities
+ the company is probably selling off its assets
- the company spends cash for investments

● financial activities
+ the company obtains cash from financial activities (e.g. takes out loans)
- the company pays its liabilities

So what are our options?

Source: own study

Here is an example of how we denote cash flows.

Source: own study

We are not using amounts for a general cash flow analysis. Therefore, the table above will look like this:

Source: own study

Cash flow - how to read them?

Now that we have figured out how to record flows, let's move on to their interpretation. According to the first table, we have a maximum of eight variants, and thus eight possible financial situations in which the company may be. We will now analyze each of them without going into the amounts.

Option 1 (+ / + / +)

What can we say about this company? The fact that it generates cash from its core activities, sells its assets (it is worth looking at the size of this flow) and incurs liabilities. It will be a highly liquid enterprise. Moreover, it is clearly raising money for (possibly) a larger investment. It sells some of its assets and takes out loans (positive investment and financial flows).

Option 2 (+ / - / -)

In this case, we are dealing with an enterprise which obtains income from business activity, additionally invests and which finances its current and investment activities from operating surpluses. It is worth taking a closer look at the size of financial flows and the size and dynamics of loans taken, which can be found in the balance sheet. If such a situation lasts longer, our attention should also focus on the profitability of the company, asking ourselves whether this type of company policy has a positive effect on the improvement of its results from sales revenues.

Option 3. (+ / + / -)

The company presented in the third variant should, colloquially speaking, force us to further analysis. Generally speaking, we have two possibilities that we can pick up after a deeper analysis. We can see that the company generates cash from operating activities, sells off assets and pays off its liabilities. In the first variant, it can be assumed that the company generates profits from investment and operating activities, thanks to which it can pay off its liabilities. On the other hand, it can be assumed (also by observing the amount of financial flows) that the company liquidates its assets.

Option 4 (+ / - / +)

In my opinion, one of the most favorable cash flow patterns. The company generates profits from its core business, invests and raises capital. This is a very good deal as the company is profitable and invests so much and aggressively that it needs additional financing.

Option 5. (- / + / +)

This is a very interesting example. The mere fact that a company has negative operating cash flow is not the best signal. It is therefore worth looking back a few years back to see if this no-profit situation persists for a long time. In addition, the company obtains profits from investment activities that may come from the sale of assets and uses external forms of financing. If the situation is relatively short and the company still obtains cash from financial activities, on the one hand, its debt will increase, and on the other hand, obtaining foreign capital may be a good prognosis. This means that lenders assess the company's condition as stable and solvent.

Option 6. (- / - / +)

The company does not generate profits again, but invests and obtains funds from external sources. It is a typical model for young enterprises that do not yet have positive revenues from operating activities, but invest intensively, at the same time needing financial support in the form of loans.

Variant 7. (- / + / -)

A very tragic variant that cash flows can represent. Of all the eight, it is by far the worst possible. You can see that the company is not making profits, it is selling off its assets to cover its liabilities.

Variant 8. (- / - / -)

We see that the enterprise does not make profits from its core business, invests and pays off its liabilities. Investing in such a company is quite risky. It seems that the operating activities are no longer profitable, and yet the company's management is investing in hopes of improving the situation.

Summation

No matter how convinced we are of the company, it is worth taking a look at the situation presented in the cash flow statement. It is quick in the overall analysis and even a moment spent on its interpretation can confirm our assumptions about the company's condition.