Companies generate financial statements to obtain a comprehensive view of performance, strength and stability. It is important to look at all three financial statements -- the income statement, balance sheet and cash flow statement -- to get a clear and accurate picture of the company's financial and operational health. Since the cash flow statement focuses solely on the company's cash, it provides a good short- and mid-term view of a company's stability.
Cash Flow Statement
A cash flow statement records a company's sources and uses of cash during a specified time frame. Sources and uses arise from operations, investing and financing. The cash flow statement provides owners, lenders and investors with a view from a cash perspective and shows how effectively a company manages to deliver performance. It also shows how well a company can cover its liabilities and expenses. Since a profitable company can have negative cash flow that could lead to business failure, small businesses should review cash flow statements on a regular schedule.
Cash from operations indicates cash flow generated or used in running the business's main activities. Analysis of this section can uncover potential problems including low inventory turnover and slow payment on accounts payable. Negative operational cash flow can indicate a fast-growing company or a company that does not properly assess a customer's ability to pay. Monitoring the cash and projecting operating cash flow out can identify potential shortfalls in advance.
Cash from investing indicates changes made in the asset section of the balance sheet. Any expenditures on or proceeds from the purchase or sale of property, equipment or other asset is recorded here. Growing companies typically show a negative investment cash flow due to all the capital expenditures. Struggling, asset-rich companies often show continual asset sales that offset negative or low operational cash flow.
Cash from financing generates cash through financing activities including stock issuance, new loans, principal repayments and distributions. Any changes made on the balance sheet in the liabilities or shareholder’s equity section is reflected here. For example, a new working capital line of credit will show up here. Warning signs include significant short-term financing and no long-term financing.
In general, companies with highly positive operational cash flow have high financial stability. Reviewing a company’s cash flow statement on a quarterly basis can help identify any operational cash shortages that need to be covered by financing or investing. Looking at all sections can tell you if a company is carrying too high a debt load that could lead to financial distress or is selling off too many assets that could leave behind a shell. A stable, growing company augments operations with cash from financing during expansion periods and takes money from operations or investing to repay financing during a holding phase.
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