Cash Flow statement should be your main focus while analyzing Financial Statements because profits earned might not translate into cash received and unless cash is received in the bank, we cannot know for sure if the profits booked are genuine. Remember cash in the bank is very hard to be falsified. To simplify, this statement is concerned with representing all the cash that has come into the business and all the cash that has gone out.
The Cash flow statement consists of 3 parts: Cash Flow from Operations, Cash Flow from Financing and Cash Flow from Investing.
So first we’ll talk about CFO. Here to ascertain the cash that has come into the business, we’ll take the Net Profit and add back non-cash charges like depreciation, accounts receivables and subtract cash charges like inventory and accounts payable to arrive at a Net CFO figure.
From this, we’ll deduct amounts invested for capacity expansion and maintenance of existing facilities. We’ll also add proceeds from sale of fixed assets to arrive at a Net cash from investing figure.
From this, we’ll deduct loan repayment, interest payments, dividends, esop expenses to arrive at Net cash from financing figure.
As investors we should track the company’s free cash flow generation. FCF is CFO – Maintenance Capex. If the company in unable to generate sufficient FCF, then it will eventually have to raise capital by issuing shares, taking on debt to survive and grow its operations. Hence great FCF across years is a very positive sign.
Along with this, another insight to draw from the Cash Flow statement especially from the CFO, is to check if the company is stuck with high amount of inventory and is having difficulty collecting receivables as this gives us an idea about the efficiency of working capital.
The cash flow statement is an important tool for investors to evaluate a company’s cash position, financial performance, dividend paying ability, identify trends, and compare it to other companies. So ensure that you do the due diligence on the cash flow statements of your prospective investment companies.
A complete analysis of the Financial Statements including the Balance Sheet, the Profit and Loss Statement and the cash flow statement is necessary for understanding the fundamentals of any company. I have analysed a few companies as examples in my blog Analysing a Few Financial Statements.
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