Definition: Cash Flow Analysis is the evaluation of a company’s cash inflows and outflows from operations, financing activities, and investing activities. In other words, this is an examination of how the company is generating its money, where it is coming from, and what it means about the value of the overall company.
What Does Cash Flow Analysis Mean?
Cash Flow Analysis is a technique used by investors and businesses to determine the value of overall companies as well as the individual branches of large companies by looking at how much excess cash they produce. They typically use the Statement of Cash Flows, a document that shows the actual cash that came in and out of the business during a certain period from investing activities, financing activities, and operational activities, as well as a few other reports.
Let’s look at an example of how this is done.
Example
Michael is the CFO of a large, public car manufacturer, and he has to periodically review the company’s financials make sure they are not in violations of any SEC rules. At the end of the second quarter, he reviews the financial statements and pays close attention to the statement of cash flows. He talks to the managers of the company’s branches to get some color on the numbers, and digs deep into the cash flow statement.
He sees that the ultimate change in cash is $1,000,000, and looks to see why that is. Starting with Net Income, he sees that Cash Flow from Operations has increased cash by $5,000,000, while Cash Flow from Investing Activities has decreased cash on hand by $15,000,000 which seems to be due to a large investment in new plant equipment, information given to him from the manager.
This results in a -$10,000,000 cash balance before Cash from Financing Activities, which provides $11,000,000 due to an issue of stock, which valued at $50 means that the company issued 220,000 shares. Seeing nothing out of order after his conversations with his managers and that thorough review, he sends in the statements to the SEC.
Outside investors also do this same analysis to see how profitable the company’s operations actually are. For instance, the cash position of the company changed $1M during the year, but its investing activities actually lost $15M. They had to issue $11M of new stock to reach this $1M surplus. This is a sign that the operations are not strong and the stock value will reflect it sooner or later.
