Financial Statement: How to Read a Cash Flow Statement
What to look for in a Cash Flow Statement and how it helps you invest.
In one of our articles, we wrote about how one can look into the annual report (or quarterly report) to pry into a company’s financial well-being. If you haven’t yet read our piece, you can find it here:
Now, you will learn from this article the information provided in a Cash Flow Statement. We will not yet delve into the methods used in churning all this information into a fundamental evaluation as that will require a much lengthier explanation and another article.
Before we proceed any further, we would like to give you a general overview of where we are.
In deciding which asset to buy, investors/traders often result to two main methods — fundamental analysis and technical analysis. Fundamental Analysis seeks to look for the actual value of a particular asset, not just look at the price that it’s listed at. Technical Analysis is more concerned with the market sentiment surrounding the asset rather than the asset itself.
One of the many things that a fundamental analyst would look into to understand the value of a company is the financial statements of a company. Under the big umbrella of financial statements, there are three main documents that analysts would look at: Profit & Loss Statement (P/L), Balance Sheet, and Cash Flow Statement.
Have a look at the other two types of financial statements here:
Before anything, it is important for you to be aware of three things:
See the time of the publication: First, know when the report was published, and you’ll also have to know if it’s a quarterly report or an annual report. The way to do it is simply by looking at the title of the report, or the preamble. Knowing this is important because each timeframe will have its own gravity in the evaluation of a company.
Say, you want to invest in Company A for the span of just a year. In this case, quarterly performance is the place to go. Of course, it’s better if you can look at both, but if time is against you then picking one is the most viable option.
See the currency denomination: When the company presents its financial data, be sure to look at the currency denomination. We’ll explain it through the example below.
The currency denomination here is when it states “(in millions)” which means that a single digit represented in the table equals a million, e.g., $1 = $1,000,000.
Yes, the things we mentioned above are perhaps really basics to many, but many of those who are newly into finance might not be aware of this.
What can a Cash Flow Statement tell you?
A cash flow statement can tell you how cash moves in or out of the company within that period. By looking at the company’s cash flow, you can get an accurate estimate of how well the company’s financials are looking for the period.
A cash flow statement is more representative of the exact amount going in and out of the company, and we’ll use the example below to make it clearer. Note, however, we have altered the time accuracy in the example to make it easily understandable.
Say, you own a furniture shop. On Monday, Customer A came in and bought a sofa for $2,000 and it was paid for in cash. That $2,000 will be reflected in your P/L Statement and your cash flow statement equally, +$2,000 on Monday.
Now, on Tuesday, Customer B comes in and bought a similar sofa for $2,000, but that will be paid in installments of $500 for 4 months, with the first payment being made on that same Tuesday. In this case, your P/L statement may show a $2,000 profit for Tuesday, but in reality, that Tuesday you only have $500 coming into your account. The rest will come in in the next few months. In your cash flow statement, however, the actual amount will be represented, i.e., you only make $500 on Tuesday.
Why is accuracy important? Because you need to see if the company actually enough money has to pay its short-term obligations. Say, from the example above, on Tuesday alone, the company must pay $1,500, or else its electric supply will be cut, and business will be affected.
(let’s assume the $2,000 on Monday has been fully used for something else), If you invest thinking that the company actually made $2,000 on Tuesday, you might be looking at a company that might be facing trouble since it only has $500 in its hands, while its short-term commitment is $1,500.
If you look into its cash flow statement, then you’ll see that the company might not be able to pay its short-term commitments.
On another note, our examples here will be from Apple’s Q1’23 Financial Statements (the data is for Apple’s Q4’22 performance). You can download it here.
The cores of a Balance Sheet
Before we start, do know that sometimes the terms used are different from one company to another, but if you look at the data they present, you’ll know they are referring to the same thing.
There are three main components of a cash flow statement that you’d want to look at cash flow from operations, cash flow from investing, and cash flow from financing activities.
First thing first
The first thing that you’d want to look at is the top-most part which states the beginning balances in a company, and near the bottom-most part of it which states the ending balances for the company. How it works is that the ending balance for the previous year will be brought to the beginning balance of this year, and so it goes.
If you look at Apple’s ending balance for 2021, however, the number doesn’t match with its beginning balance in 2022. Why so?
As you can see, FY 2021 accounting period ended on December 25th, so there’s a 6-day gap from that date until FY 2022 begins. Within that 6 days, many transactions can affect the balance, such as their investment activities, currency exchange activities, or even the money they spent on their employees for Christmas Eve. So, the beginning amount in 2022 reflects all the transactions that occurred after December 25th, 2021.
So, from this part of the cash flow statement, you can roughly tell how much cash the previous financial year has prepared the company with, or how much cash they are making in the currently reported financial year.
Note: sometimes it can be negative, but the previous or the next year’s amount may be enough to offset the losses.
Cash Flow from Operating Activities
In the operating activities segment, they will tell how much the company makes or spends during that period from its operations. This refers to the money they made or spent on their core business activities, like Apple selling their products (iPhone, iPad, Macbooks, etc.) or services (cloud service, Apple Music, etc.), including the hiring they do, or the ads they put up — so long as it relates to its core business activities.
You can see the money they make mentioned without brackets while the money they spend are in brackets. Now we won’t explain in detail what each of the lines means, so long as you understand the basics of it since different companies mention different things in their cash flow statement.
The first thing that you’d want to look at is the one at the bottom, i.e., cash generated by the operating activity which tells you the potential of the company to make a profit. The content of this segment is how much the company makes in that period having considered its revenue, the wages it paid its staff, and the ads it put online, all things that fall under a company’s operation fall under this. As a general rule, usually, a company with a positive operating activity segment is a good signal, but of course, it’s not necessarily so at times. Some people are just fine looking at this without even looking into the details of it.
The next thing you’d want to look at is its net income, which tells you how much income the company has generated from its activities for the period, without including other things like asset depreciations, etc.
There is also the adjustment to reconcile net income to cash generated by operating activities line which essentially adds or subtracts from the amount of any non-cash expenses like depreciation and amortization (it tells you how much your asset depreciates in value over the years). To reconcile net income to net cash flow, non-cash expenses must be added back to (or deducted from) net cash flow.
Finally, you can also look into the changes in operating asset and liabilities segment which tells you how the cash flow in the company’s assets and liabilities account has changed. For example, when you look at the inventories and the numbers come out negative (1,807), you can tell that the company bought some things to fill its inventories.
Cash Flow from Investing Activities
This part will tell you how much cash is being used to invest, or how much is being gained from investments. There’s no need to explain the details of it as it’s pretty much self-explanatory. In this part, the payments for acquisition of property, plant and equipment are usually looked at by investors if they want to see whether the company is trying to expand or not.
Cash Flow from Financing Activities
This segment tells how much the company makes from its financing activities, which may include borrowing money, repaying its debt, paying taxes, and other things. As we can see from Apple’s example above, their FY2022 is dominated by them repaying their financial obligations.
What to do with a company’s cash flow
What to do with a cash flow statement? If you’re looking for a more general overview of things, what you can do is you can compare the total balance between one financial year with another, this is to see if the company is making good progress with its cash, or simply just a cash gobbling machine.
You can also compare each segment by year to see how the company is progressing in a specific part. For example, you can see how much they invested this year compared to the previous year. You can also refer to previous financial statements to see if the investment is marginally big or relatively small compared to their previous investment, for what purpose, and such.
You can also look into the details of it, depending on what aspect of the company you want to know more about. Is the company seriously expanding its business? Well, take a look at its cash flow from investment activities. Are they good at managing their debts? Look at their debt repayment each year, or are they raking a mountain of debt while repaying a pinch of it year by year?
It’s like looking into someone’s bank account. You can roughly tell how well a person is doing through the ways they earn and the ways they spend.
A more advanced investor/trader might use the information provided in the cash flow statement, profit & loss statement, and balance sheet by processing it using various methods such as financial ratio analysis and more. However, that will require an article of its own.
- A cash flow statement consists of three activities — operating, investing and financing.
- A net cash flow amount will tell you the total money spent/earned for the period.
- Operating activities are most commonly looked at in a cash flow statement.
- The cash flow statement can be used to see the company’s long/short-term liquidity, whether it can pay for its short-term commitments, whether the way they spend its cash is sustainable or not, etc.
- A cash flow statement is also used to measure a company’s strength and profitability.
- it can tell you about the future outlook of the company based on how they spend.
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None of the material above or on our website is to be construed as a solicitation, recommendation or offer to buy or sell any security, financial product or instrument. Investors should carefully consider if the security and/or product is suitable for them in view of their entire investment portfolio. All investing involves risks, including the possible loss of money invested, and past performance does not guarantee future performance.