THE CASH FLOW STATEMENTS- FUNDAMENTAL ANALYSIS

The cash flow statements of a company basically show how much cash comes in and how much goes out in a given period. Cash flow statements do not take into account accrual accounting and only record when cash is swapped not when transactions for revenue and expenses are made.

Cash flows statements are one of the important financial statements that investors should analyse in the fundamental analysis as cash flow statement provides actual cash generated by the company, it tends to reflect the company’s stability and fundamentals by showing how much cash is possessed by the company to pay for its operations.

Investors before making investment decisions should evaluate a company’s capabilities to generate cash as showing profit in the income statement is not enough to ensure sufficient cash flows in a company. Hence, examining the cash flow statements can provide a broad idea to investors about a company’s growth and stability.

As cash is generated and spent in different aspects in a business, there are three sections in a cash flow statement, Cash flows from:

  • Operating activities
  • Investing activities
  • Financing activities

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Cash Flows from Operating activities

Cash flow from operating activities shows the amount of cash that comes from the sale of goods and services of a company, minus the amount required to make and sell those goods and services. Investors usually prefer the companies that generate positive cash flow from operating activities. Changes in cash flow from operating activities provide a sneak of changes in net future income and it is considered a good sign if it goes up. Investors should look out for a widening gap between company’s announced earnings and cash flow from operating activities as if net income is more than cash flow, then it is expected that the company is either bolting or slowing its booking of incomes or costs.

Cash Flows from Investing activities

This part of the cash flows tend to reveal the amount of cash incurred by the company on capital expenditures, that may include, new equipment, machinery or more that help in running the business. This may also include investments or acquisitions by the company.

Investors should be aware that capital is reinvested in the business by companies by at least the rate of depreciation expenses every year as companies may show false high cash inflows if reinvestment is not done, which may prove to be irrational.

Cash Flows from Financing activities

Going on cash related to outside financing activities is shown in cash flows from financing activities. In this section, cash inflows include cash raised by selling stocks and bonds etc. and cash outflows can be paying back a bank loan, dividend payments and more.

Investors tend to be interested in companies that hold and produce enough free cash flow (FCF). Free cash flows indicate that a company is capable of paying debt, dividends, buying back stock and eventually can increase future growth. Free cash flow is surplus cash produced by the company and this can be used to provide returns to shareholders. A company can also look for investment opportunities through free cash flows and prosper its growth in business.

If a company is able to pay for investment purposes out of operations without counting on outside financing, then investors tend to get attracted to the company as company’s ability to pay without borrowing from outside options indicate growth status of the company and strong fundamentals that make that company an ideal option for investors to invest in.