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As it applies to individuals and for companies also, cash plays a very important role and it concentrates on the financial health of the company. Cash flow statement, thus, needs to be analysed while evaluating a stock along with its other financials like Profit and Loss Statement and Balance Sheet.
But what is cash flow statement? What should we understand from it, and what to look for in the cash flow statement? Let’s understand in this video.
Cash flow statement is a statement which gives an analysis of the cash inflows and outflows in the company during a financial year. It is a statement where the cash received and cash paid are being recorded for a specific period of time.
All the cash flows received and paid are recorded into 3 categories of cash flow.
Cash Flow from Operations-
These include the cash flow from the principal business activity of the company. That is, the cost incurred for manufacturing a product or service as the main business of the company. For example, depreciation and amortization of the product or machinery, Interest paid for a loan for running the business are recorded under this.
Cash Flow from Investing-
All the investment-related activities like acquisitions and disposals of assets are recorded under this head. Also, any kind of loan given or dividend received or Interest received is recorded under this.
Cash Flow from Financing-
A company needs finance for its regular working. Some financing related activities for the company include equity capital, borrowings, etc. which are recorded under this head. It also includes items like Dividend paid, Buyback, Repayment of long term or short term borrowings etc.
So, it’s basically said that the Cash flow from operations should be positive, which means the company is earning from its business operations, and this is a good sign for any company.
Similarly, the Cash flow from Investing should be negative for any company which means that the company is regularly infusing cash in new ventures or business, or doing capex for future wealth creation.
Thirdly, the Cash flow from Financing should always be positive, which means that the company is borrowing and investing it to create positive operations for the future growth of the company.
These are the three categories where the cash inflows and outflows are recorded on the basis of their nature.
Now let us see why the cash flow statements are prepared-
- It helps the stakeholders to have an overall understanding of the health of the company.
- It helps to have a clear understanding of the cash flows of the company under different activities like operating, financing and investing.
- As we believe that Cash is King, a clear overview of the cash flows is obtained, and the optimum cash balance and the factors influencing the cash flow are ascertained for any investment idea generation.
- Cash flow helps in better capital budgeting decisions as it clearly shows the movement of cash.
- It is said that Cash Flows are difficult to manipulate by any company, thus giving an ideal picture of the financial health of any company.
Cash flow can be a very important statement, but it also has its limitations. A few drawbacks of the cash flow statement are-
- Cash flow statement is prepared on a historical basis, hence no future or projected cash flows are considered.
- It also doesn’t consider economic indicators like industry comparison etc.
- It doesn’t consider non-cash items, hence the net income of the company is not presented accurately in the cash flow, as some capital-intensive companies have high non-cash items in their books.
A cash flow statement is very important in understanding the financial health and future performance of the company. The movement of cash, the optimum cash balance and the deployment of cash in the business etc, act as performance-measuring metrics for a company. Keep analysing Cash flows along with other financial statements.
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