How to Read a Statement of Cash Flows (Part 2)
In Part 1 of this blog, we discussed the purpose of the Statement of Cash Flows and how to read the information provided in the operating activities section. In this article, we will conclude the discussion of the Statement of Cash Flows by explaining the investing and financing activities sections of the report.
As the name implies, the investing activities section covers transactions relating to investments, whether they are in the form of marketable securities (stocks, bonds, or mutual funds) or capital assets, such as land, buildings and equipment. In this section, a purchase of a capital asset or financial security would be shown as a decrease in cash, while the proceeds from a sale of one of these assets would be an increase in cash. Generally speaking, a growing business is expected to have a net decrease in the investing activities section of the Statement of Cash Flows, mainly because it is expected that the business will require investments in infrastructure or equipment.
Financing activities relate to how a company raises and pays off working capital, whether it comes in the form of ownership investment or third party debt. Contributions made by an owner or sales of capital stock are reported as an increase in cash, and dividends or distributions to owners is shown as a decrease in cash. For debt financing, proceeds received from a loan are shown as an increase in cash, and the principal portion of debt payments are shown as decreases in cash. Whether a company has a net increase or net decrease in cash flows from financing activities can probably tell you what phase a company is in. A large increase in cash from financing typically shows that a company is preparing for growth, while a decrease in this section implies that a company is at a mature, operational phase.
To those without a deep financial background, the Statement of Cash Flows is considered the most confusing and complex of the primary financial reports. In order to get a full picture of the health of a company, though, it is important to have at least a baseline understanding of how to read the Statement of Cash Flows and interpret the information in each section.
About the Author
Tim Peters is a consultant with Morrison, working primarily in our Business & Accounting Advisory practice. To get in touch with Tim, please find contact information for Morrison here.