Cash Flow Statement Analysis
A company can report a profit and still run out of cash. The cash flow statement shows where cash really came from and where it went, split into operating, investing and financing activities. Finance courses also use the cash flow identity to link the firm's assets to its lenders and owners.
The cash flow statement explained simply
The cash flow statement shows where a company's cash came from and where it went, in three parts: operating, investing and financing. Net change in cash = CFO + CFI + CFF. In the example, +300 − 200 − 50 = +50, so cash rises from $100 to $150.
What this cash flow statement lesson covers
- Why profit and cash are not the same thing
- What goes in the operating, investing and financing sections
- How to read the signs: which flows should be positive or negative
- How cash flow from assets splits between creditors and stockholders
Cash flow statement formulas, explained
- CFO
- Cash flow from operating activities
- CFI
- Cash flow from investing activities (usually negative when the firm buys assets)
- CFF
- Cash flow from financing activities (borrowing, repaying, issuing shares, dividends)
- Cash flow from assets
- Operating cash flow − Net capital spending − Change in net working capital
- Cash flow to creditors
- Interest paid − Net new borrowing
- Cash flow to stockholders
- Dividends paid − Net new equity raised
How to read a cash flow statement step by step (worked example)
A company starts the year with $100 of cash. Operating activities bring in $300, it spends $200 on new equipment, and it repays $30 of debt and pays $20 of dividends. What is its ending cash, and what does the pattern say?
- CFO = +300
- CFI = −200 (equipment purchase)
- CFF = −30 − 20 = −50
- Net change in cash = 300 − 200 − 50 = +50, so ending cash = 100 + 50 = 150
Answer: Ending cash is $150. Operations fund both the investment and the payouts to lenders and owners, which is the pattern of a healthy, self-funding business.
Operating vs investing vs financing cash flow
| Operating | Investing | Financing | |
|---|---|---|---|
| What's in it | Cash from running the business | Buying and selling long-term assets | Borrowing, repaying, issuing shares, dividends |
| Usually, for a healthy firm | Positive | Negative (it's investing) | Either sign |
| In the example | +$300 | −$200 | −$50 |
| Red flag | Negative year after year | Positive because it keeps selling assets | Borrowing to cover operating losses |
What does a healthy cash flow pattern look like? David's take
Look at the pattern in the example: operations bring in $300, which pays for new equipment and for the lenders and owners, and cash still goes up. That's a business that funds itself, a machine that makes money. My line is: don't waste your time making money; use your time making machines that make money. The operating section tells you whether the machine runs on its own or has to keep being fed with new borrowing.
From David's concept: Machines That Make Money. This is David's opinion, alongside the standard textbook answer above.
Harder cash flow statement questions
Is negative operating cash flow always bad?
Not always. A fast-growing company may pour cash into inventory and receivables before customers pay, so operating cash flow dips while sales climb. Negative operating cash flow year after year, though, means the business isn't paying for itself.
What does positive investing cash flow mean?
The company sold more long-term assets than it bought. That can be a sensible clean-up, but if it happens every year it can mean the company is shrinking or selling assets to stay afloat.
Why can profit and operating cash flow differ so much?
Profit includes non-cash items such as depreciation and counts sales before the cash arrives. Operating cash flow adds back the non-cash items and adjusts for changes in working capital, so it shows the cash the business really produced.
Common cash flow statement questions
What are the three sections of a cash flow statement?
Operating activities cover cash from the day-to-day business. Investing activities cover buying and selling long-term assets such as equipment. Financing activities cover borrowing, repaying debt, issuing or buying back shares and paying dividends. Together they explain the change in cash.
What does negative cash flow from investing activities mean?
It usually means the company is buying more long-term assets than it sells. For a growing business that is normal and often a good sign. It becomes a worry only if operating cash flow cannot cover it for years and the gap is filled with constant borrowing.
Why can a profitable company have negative operating cash flow?
Profit includes sales that have not been collected yet and ignores cash tied up in new inventory. If receivables and inventory grow fast, cash goes out before it comes back in. That is why analysts check operating cash flow alongside net income.
What is the cash flow identity?
It says cash flow from assets equals cash flow to creditors plus cash flow to stockholders. In plain English, whatever cash the firm's assets generate must go to, or come from, the people who financed those assets: lenders and owners.