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What is Cash Flow Statement & How to Read it by Gaurav Heera?

Asjad Sahil by Asjad Sahil
June 22, 2022
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What is Cash Flow Statement: Any company mainly prepares three types of financial statements to state its financial condition – Balance Sheet, Income Statement and Cash Flow Statement says Gaurav Heera.

 

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To do fundamental analysis of any company, it is necessary that you have the correct information about these three financial statements. So friends, in this series of Fundamental Analysis, today we will talk about what is a cash flow statement, why make a cash flow statement and how to read this statement says Gaurav Heera.

 

What is Cash Flow Statement?

 

A cash flow statement is a financial statement that gives information about the cash flow in and out of the company. Also, it tells what has changed in the cash position of the company during that period.

 

Generally, we analyse the cash flow statement from the company’s annual report. In this, the period of the company’s cash flow statement is 1 year.

Why is cash flow statement prepared?

 

Now you must be thinking that when the company has already given the information of net profit in its income statement, then what is the need to prepare cash flow statement says Gaurav Heera.

 

Let us understand it with a practical example –

 

Let’s say a company sells 100 laptops in a year, whose cost of one laptop is ₹ 10,000. Thus the total sales of this company after a year was ₹10 lakhs.

 

But this company has sold 50 out of 100 laptops on credit, whose money has not actually come to the company yet. Now you will see a revenue of ₹ 10 lakhs in the income statement of the company, which is very good in appearance but in reality it is not so.

 

The actual cash with the company is only ₹ 5 lakhs. If there is a short term liability of ₹ 6 lakh on this company, then the company will not be able to meet it because only ₹ 5 lakh is lying in the company’s bank says Gaurav Heera.

 

You get all this information from Cash Flow Statement.

 

Income statement or P&L account is prepared on accrual basis of accounting. That is, all the transactions (Revenue and Expenditure) are recorded in the income statement whether there is any cash transaction in them or not. But in the cash flow statement only those transactions are recorded which are done in cash.

 

How to prepare Cash Flow Statement?

 

Cash flow statement is made up of 3 items –

 

  1. Cash Flow from Operating Activities
  2. Cash Flow from Investing Activities
  3. Cash Flow from Financing Activities

 

Net Increase or Net Decrease is extracted by adding the final figure of these three items.

How to read Cash Flow Statement?

 

To read the Cash Flow Statement, you have to understand the three activities separately.

 

Cash Flow from Operating Activities

 

The activities that any company does in order to run its business comes under operating activities. In this, the cash flow is calculated by deducting the purchases and general expenditure from the total sales. In addition, taxes are also deducted from operating activities says Gaurav Heera.

 

Total Sales – Purchases – General Expenditure – Taxes = Cash Flow from Operating Activities

 

For example, ABC Ltd. has purchased goods worth 100 crores during the year. The total sales of the company during this period stood at ₹200 crores. While the general expenditure of the company stood at ₹ 30 crores. If the company has paid tax of 20 crores on its profit, then the company’s Cash 

Flow from Operating Activities will be as follows –

 

Amt in Crores
Cash Received from customers ₹200
Cash paid to suppliers (₹100)
General Expenditure (₹30)
Tax Paid (₹20)
Net Cash Flow from Operating Activities ₹50

 

Thus the Cash Flow from Operating Activities of this company will be ₹ 50 crores. While assessing any company, it must be seen that their Cash Flow from Operating Activities is in positive.

 

Cash Flow from Investing Activities

 

This includes the investing cash flows of the company. In which negative cash flow can include investing by the company somewhere such as buying an asset, buying mutual funds or shares, etc.

 

Positive cash flow includes the company getting rent, receiving interest, selling a property, etc.

 

Amt in Crores
Sale of Land ₹200
Purchase of Equipment (₹300)
Mutual Fund Buying (₹30)
Interest Received ₹5
Net Cash Flow from Investing Activities (₹125)

 

In this example the net cash flow of the company was ₹125.

 

Cash Flow from Financing Activities

 

Such activities include cash flows that affect the debt and equity capital of the company, such as taking or repayment of new debt, paying dividends, issuing new shares or buying back shares.

 

By adding the Net Cash Flow of Operating, Investing and Financing activities, we get Net increase or Net decrease. Which we add to the opening balance of cash and calculate the closing balance of cash for the end of the year says Gaurav Heera.

 

Let us take net increase or net decrease from the above example –

 

Amt in Crores
Common Share Dividend Payment (₹100)
New Debt taken ₹300
Net Cash Flow from Financing Activities ₹200

 

Thus the cash of ABC Ltd has increased by a total of ₹125 crores at the end of the year.

 

Types of Cash Flow

 

(1) Positive Cash Flow – When the cash coming into the company is more than the money going out of the company, then there is a positive cash flow.

 

(2) Negative Cash Flow – When the cash coming into the company is less than the case going out of the company, then it is a negative cash flow.

 

(3) Break Even Cash Flow – When both the cash coming into the business and the cash going out of the business are equal, then it is called break even cash flow.

What to Look for in Cash Flow Statement?

 

Friends, the most important point of Cash Flow Statement is Cash Flow from Operating activities. If this cash flow of a company is negative, then it means that the company is not able to cover its expenditure from its sales.

 

Whereas the company whose cash flow from operating activities is in positive and is growing continuously, that company is considered to be financially strong says Gaurav Heera.

 

If a company’s cash flow from operating activities is more than its net income, then even then the company’s earnings are considered to be of high quality.

 

conclusion

 

Friends, while doing the fundamental analysis of any company, you have to look at many factors, cash flow statement is also an important factor among them. So you should pay a lot of attention to the balance sheet, income statement as well as cash flow statement. Only then you will be able to choose a good fundamentally strong company.

 

Today in this article you learned what is Cash Flow Statement, how to read Cash Flow Statement.

 

So I hope you liked this article on Cash Flow Statement. If you like the information, then definitely share it with your friends on social media networks.

 

About Author

Gaurav Heera is a stock market expert, investor, trader, author & Edupreneur. He has trained already more than 5000 students through his stock market course in Delhi. You can even checkout his blog for free stock market courses & updates.

Read also: rackstreamnews

 

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