With cash, comes purchasing power and cushion to absorb shocks. Cash Inflow and Outflow is an important factor to determine the cash position of any firm. It is vital to meet short-term obligations. To understand the financial health of any company, financial analysis involves squeezing underlying information from the Cash flow statements or Fund Flow statements. Let’s increase our financial quotient “FQ” and understand the purpose of cash flow analysis or Fund Flow Statement Analysis in detail.
To understand the purpose of cash flow analysis, let’s consider a scenario–
My friend is 28 years old, working in an MNC. For him, the salary credited to his account every month is Cash flow from operating activity- as it’s coming from his main occupation. Now he has invested some of his family’s savings in buying an apartment & renting it. The monthly rent that he gets becomes his cash flow from investing activities. Lastly, he also bought some shares of Blue-chip companies, so dividends that he gets out of them can be termed as cash flow from financing activities.
Cash Flow Analysis or Fund Flow Statement Analysis
It can be further broken down into – Cash from Operating Activities, financing activities, and from investing activities.
Cash from Operating activities
- It includes measuring the cash inflows and outflows caused by core business operations
- Calculated by adjusting the Net income. Common Adjustments include Depreciation, Profit / Loss on Sale of Financial Assets, Changes in Working Capital (excluding cash) etc.
Cash from Investing activities
Changes in equipment, assets, or investments relate to cash from investing. Usually, cash changes from investing are a “cash-out” item. It is because you need cash to buy new equipment, buildings, or short-term assets such as marketable securities. However, when a company divests an asset, the transaction is considered “cash in” for calculating cash from investing.
Cash from Financing activities
Changes in debt, loans, or dividends are accounted for in cash from financing. Changes in cash from financing are “cash in” when capital is raised, and they’re “cash-out” when dividends are paid. By accepting Fixed deposits from Public or known parties, the company receives cash financing. However, when fixed deposit holders receive interest on their deposits, the company is reducing its cash.
Purpose of Cash Flow Analysis/Fund Flow Statement Analysis
Comparing a company’s cash flow against its industry peers is a good way to gauge the health of its cash flow situation. The company not generating the same amount of cash as competitors will eventually lose out when time gets rough. Thus cash flow analysis of a company reveals a lot about the company’s financial health.
- Comparing amount of cash generated to outstanding debt, known as the operating cash flow ratio (CFO/CL), illustrates the company’s ability to service its loans and interest payments.
- If a slight drop in a company’s quarterly cash flow would jeopardize its loan payments, that company carries more risk than a company with stronger cash flow levels.
Apple is the company with the highest Free Cash Flows $7.17 billion in 2020, followed by Verizon with $2.11 billion FCF (Free Cash Flow)
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