Cash Is King, But Cash Flow Statements Rule The World

As a CFO, one of the first things I’m asked when I walk into a room is how I begin to evaluate a company. First and foremost, I always use financial statements and financial information. However, in almost 95% of the cases, I tend to focus on the cash flow statement. It tells me a lot about how a company is doing, where they are investing, and where the money is flowing.

Unfortunately, in most cases, the cash flow statements produced by accounting systems are either unusable or unreliable, so I tend to have to create my own. Now, jumping in and creating a cash flow statement is not for the timid, and even I know some very experienced CFOs and accounting professionals who can’t create one from scratch, but it’s important to understand the inputs to a cash flow statement as well as the outputs and how they’re used.

Understanding Cash Flow Statements

Cash flow statements consist of three sections: cash from operations, cash from investing activities, and cash from financing activities. Those are, of course, broad categories but they can tell us a big story about what's going on within a company.

It's important to remember that a cash flow statement is derived from the income statement in the balance sheet. The income statement is a capture of activity over time, and the balance sheet is a capture of a moment in time. Combining those two into a single statement is challenging.

Starting with cash flow from operating activities (CFO), you can get a very clear picture of what kind of cash is being generated from day-to-day, week-to-week operations. I also look at cash flow over longer time periods to understand how that's impacted. For example, if I'm given a cash flow statement for one month, I will also run it for that particular year to get a better understanding of what's happening.

By looking at cash flow from investing activities (CFI), you can see how much cash has been generated or spent from various investment-related activities during a specific period. Investing activities include purchases of physical assets, investments in securities, or the sale of securities or assets. Negative cash flow is often indicative of a company's poor performance; however, negative cash flow from investing activities might be due to significant amounts of cash being invested in the long-term health of the company, such as research and development.

Cash flow from financing activities (CFF) shows the net flows of cash that are used to fund the company. Financing activities include transactions involving debt, equity, and dividends. Cash flow from financing activities provides stakeholders with insight into a company’s financial strength and how well a company's capital structure is managed.

Using this information is key to understanding the value and the structure of the company—far more than any other financial statement.

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