The Cash Flow Statement
The statement of cash flows discloses the cash entering and leaving a company during the reporting period. Many seasoned investors swear by this document as being the true indication of a company’s success or failure. Investigating this statement can help predict future cash flows, determine the company’s ability to pay their debts and/or dividends, and will help the investor assess the current management.
Three categories exist within a cash flow statement, and are used to further break down this flow of liquidity. Operating, Investing, and Financing Activities each describe specific areas of income and expenditures, while encompassing the whole of financial activities. Supplemental details that didn’t involve cash follow these sections.
Operating Activities create revenue or expense within the business itself. This is where the items reported on the income statement are explained from the basis of cash. Anything pertaining to business operations should show here.
Investing Activities include cash flowing in from the sale of investments and cash leaving to the purchase of long-term ventures. These investments often include assets, including property, plants, and equipment.
Financing Activities report on the flow regarding liabilities and equity. Dividends, issuance of bonds or shares of the company, and repurchasing stock shares are all found under this category.
Supplemental details are then reported on taxation, interest payments and other significant items that didn’t involve cash. These transactions are often referred to as non-cash investments or non-cash financing activities. Such items should always appear at the bottom of a statement of cash flow, or in the accompanying notes.
Free Cash Flow
Investors want to know how much cash on hand a company can use toward new opportunities or reinvesting in existing ventures. Cash generated by operating activities, after being deducted by long term investment payments and dividends is known as Free Cash Flow (FCF). FCF is commonly used as an indicator of the performance of a company. To break FCF down further, the calculation is as follows:
where EBIT is Earnings Before Interest and Taxes. EBIT is the result of taking operating expenses from revenue. On a multi-step Income Statement, EBIT is the Operating Profit (or Operating Earnings).