Acra, October Cash flow is a revenue or expense stream that changes a cash account over a given period. Cash inflows usually arise from one of three activities – financing, operations or investing – although this also occurs as a result of donations or gifts in the case of personal finance.
Cash outflows result from expenses or investments.
Cash flow analysis is a critical process for both companies and investors. It’s also a complex process that can leave the average investor with the feeling of seeking advice from a competent financial advisor just might be a good idea. If you aren’t an accountant or a Chartered Financial Analyst, you might want to have a better understanding of what “cash flow from investing” means to business and investors alike; there are just a few basic concepts that you need to understand.
Cash Flow Components
Corporate cash flow statements include three components:
• Cash flows from operating activities
• Cash flows from investing activities
• Cash flows from financing activities
Cash flows from operating activities refer to money generated by a company’s core business activities. This number highlights the firm’s ability (or inability) to make a profit. While it provides good insight into whether or not the firm is making money, the other components of the cash flow statement also need to be taken into consideration in order to develop a more complete picture of the company’s health.
Consider “cash flows from investing”. Intuitively, cash flows from investing may sound like the amount of money a company generates from investments it has made, but the accountants who fill out corporate balance sheets are generally not referring to the number of shares of a company it has bought or the number of municipal bonds it has sold. Rather, from a corporate perspective, they are generally referring to money made or spent on long-term assets the company has purchased or sold.
Upgrading equipment and buying another company to take over its operations and gain access to its clients and technology are investment activities from a corporation’s point of view. Both of these activities cause companies to spend money, which is captured on a cash flow statement as negative cash flow. Similarly, if a company sells-off old equipment or sells a division of its operations to another firm, these activities are also captured on paper as income from investing.
Cash flow from financing activities measures the flow of cash between a firm and its owners and creditors. Corporations often borrow money to fund their operations, acquire another company or make other major purchases. Timely operational expenditures, such as meeting payroll requirements, would be one reason for cash-flow financing. Companies are essentially borrowing from cash flows they expect to receive in the future by giving another company the rights to an agreed portion of their receivables. This allows companies to obtain financing today, rather than at some point in the future.
Cash Flow Indicator Ratios: Operating Cash Flow/Sales Ratio
This ratio, which is expressed as a percentage, compares a company’s operating cash flow to its net sales or revenues, which gives investors an idea of the company’s ability to turn sales into cash.
It would be worrisome to see a company’s sales grow without a parallel growth in operating cash flow. Positive and negative changes in a company’s terms of sale and/or the collection experience of its accounts receivable will show up in this indicator.
Formula:
What It Means to a Business
Cash flow is a key element of a successful business. Generating positive, sustainable cash flow is critical for a firm’s long-term success. Keeping track of that cash flow is particularly important to business owners. The way that cash flow is captured and tracked plays a significant role in how businesses project their financial health to potential investors. A brief overview of cash and accrual accounting provides insight into the way accounting rules require companies to record revenues and expense.
For example, when a company sells a TV to a customer who uses a credit card, cash and accrual methods will view the event differently. The revenue generated by the sale of the TV will only be recognised by the cash method when the money is received by the company. If the TV is purchased on credit, this revenue might not be recognised until next month or next year.
Accrual accounting, however, says that the cash method isn’t accurate because it is likely, if not certain, that the company will receive the cash at some point in the future because the sale has been made. Therefore, the accrual accounting method instead recognises the TV sale at the point at which the customer takes ownership of the TV. Even though cash isn’t yet in the bank, the sale is booked to an account known in as “accounts receivable”…increasing the seller’s revenue.
What It Means to an Investor
Cash flow from operating activities is an important source of data for investors. Net income, depreciation and amortisation, as well as changes in working capital, are included in this section of the corporate cash flow statement. The net number can be positive or negative.
As noted earlier, cash flow from financing activities measures the flow of cash between a firm and its owners and creditors. Negative numbers can mean the company is servicing debt but can also mean the company is making dividend payments and stock repurchases, which investors might be glad to see, Business debt collection is never fun, but a necessary step to keep your business safe, so to avoid a debt in your business management find the right professional for your finances.
While “negative” cash flow doesn’t sound good, it isn’t always bad – sometimes you’ve got to spend money to make money. Companies need to invest in their businesses in order to grow. Conversely, high cash flow doesn’t mean the company is in good shape – it may just be selling off assets. Non-recurring revenues such as making GH¢1billion by selling-off a division boost cash flow, but that division can’t be sold again next year.
When reviewing the numbers, it is critical that income generated by such non-recurring events as sale of fixed assets, securities, retirement of capital obligation or litigation be taken into proper consideration. Any or all of these numbers could represent a one-time profit or loss that would distort the firm’s prospects if viewed as recurring items.
Conclusion
Clearly, cash flow analysis is complex but a useful topic for investors when analysing the health of a specific company. Just keep in mind that a company’s cash flow statement is only one source of data providing insight into a firm’s health. Other important sources of information include a firm’s balance sheet and income statement. Be sure to conduct a thorough review of all relevant data before making an investment decision. If you have any doubts about your ability to sort through the numbers and make a good decision, seek the assistance of a professional to guide you with your stock selection needs.
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Analysts: Nana Kumapremereh Nketiah (JP)
Sophia Obeng –Aboagye
Omega Capital Research
