In a set of financial statements, the one that lends credibility to the others is the Cash Flow Statement. Management, lenders, stockholders, potential investors, and valuators use this statement to assess the financial health of a business, whether the organization is for profit or a not-for-profit.
The statement reports three primary activities:
- Operating
- Investing
- Financing
The operating activities area of the statement includes some important information like profit or loss of the business; deprecation; changes in inventory; changes in accounts receivable; and changes in accounts payable. All these line amounts can tell a story of good or bad business operations. The bottom line of this area is referred to as “net cash from operating activities .” You want this amount to be at least consistently positive and growing. If not, the business is probably suffering from some bad decisions or some outside factor which needs to be dealt with soon. Keep in mind that this area reports the cash flow engine of the business.
The investing activities area of the statement reports investing information such as purchases of fixed assets and making long-term investments. Look here to see if this business is investing in itself. A healthy business is always buying assets to replace obsolete ones. Look for trends from prior years like how much and when certain assets are purchased.
The financing activities area of the statement reports financing information like borrowing, repayments of debt, and dividends. The trends over several years are important to watch as they can present a good news or bad news situation. One good news situation is debt that is being retired, where as a bad news situation would be new debt being obtained to fund negative cash flow from operating activities.
The cash flow statement tells all if understood and evaluated properly. It resembles a puzzle of the business, and when solved can provide the reader a heads up on how well management is running the business and problem areas that need attention.
