How to Read a Cash Flow Statement

Hello, I am Umesh Tripathi and we are learning the concepts of Fundamental Analysis. We learn how to read the Cash Flow Statements. Along with this, we will also study the main components of Cash Flow Statements. And at the end of the video, we will learn with an example how to read the Cash Flow Statement in detail. 

In any financial statement, Cash Flow Statement basically is the record of the cash inflows and outflows. As we have seen in the previous videos, in the Profit and Loss Statement we talk about revenues and profits. In the Balance Sheet we talk about liabilities and assets. So somewhere in between, cash comes into the picture. 

Now, for example, let us assume some company is running a particular business. And to run its operations, it needs some cash. So some part of the cash has to outflow in order to run that particular business. Now here, suppose there is an auto company and that auto company has to manufacture some auto ancillary parts. In this case, to manufacture those parts, there need to be some kind of expenses that go into procuring those materials which are used for manufacturing those particular parts. Now here, cash outflow is happening to run this particular operation. 

In some cases, what happens is that a company, to do a certain kind of business expansion, takes some loans. Now here, in a way, cash inflow is happening. So when we talk about the Cash Flow Statement, we are actually talking about the real cash, and it is basically a key to link together the Balance Sheet and the Profit and Loss Statements. It is very difficult to manipulate the Cash Flow Statements because it gives a real picture of how the cash inflows and outflows are happening in a certain business. 

Now let’s talk about the key components of the Cash Flow Statement. So, in the Cash Flow Statement, basically there are three main components: 

1. Cash Flow from Operating Activities 

2. Cash Flow from Investing Activities 

3. Cash Flow from Financing Activities 

So basically, all the major operational activities like revenue generation sources, expenses, or taxes, these come under Cash Flow from Operating Activities. 

Let us take an example here. Under the example of Cash Flow from Operating Activities, we can say that whatever the customers are paying to buy certain products or certain services—that payment from customers is cash inflow, cash being received. And whatever we are paying to the suppliers to run the business, that is actually a cash outflow from the business. 

Under Cash Flow from Investing Activities, basically what companies do is that they tend to purchase property or do procurement of certain businesses, and this requires cash. Either the company is buying a factory or selling any kind of machinery, there is some kind of cash inflow and outflow happening from and to the company. So these kinds of activities come under Cash Flow from Investing Activities. 

If we talk about Cash Flow from Financing Activities, then all the capital structure changes like loans and dividends actually come under Cash Flow from Financing Activities. As an example, we can say that whenever a company is issuing new shares, or is buying back shares, or is issuing bonds, or is repaying its debts—these are the cases where cash inflow and outflow happens. And all these activities come under Cash Flow from Financing Activities. 

Now let us take some examples of inflows and outflows so that you can clearly understand how inflows and outflows of cash happen under Operating, Investing, and Financing Activities. 

So, if we talk about Operating Activity, then under inflows we can put cash sales and interest income as examples of cash inflows. If we talk about outflows under Cash Flow from Operating Activities, then here whatever salaries we pay to our employees, or whatever rent we are paying, or whatever taxes we are paying—these are all cash outflows. 

And when we talk about Investing Activities, if the company is selling its assets then basically it’s a kind of cash inflow, because by the sale of assets it is actually generating some kind of cash. And on the other hand, when it is purchasing assets, it is basically investing by doing some kind of cash outflow. Okay? 

If we talk about Cash Flow from Financing Activity, then here are some examples: when the company is issuing shares, then there is cash inflow. When it comes to loans, then again there is cash inflow. Basically, when a company is taking a loan, although it is taking debt, but at that particular time there is cash inflow for it. When it is repaying a loan, in this way they are actually repaying the loan but cash outflow is happening from the business. Okay? Along with this, whatever dividends a company gives, that is a kind of cash outflow from the business. Okay? 

Now let us talk about how to read the Cash Flow Statement. So here basically, we will start with the Operating Activity. In the Cash Flow Statement, we need to look for net cash from Operating Activity. If we see a positive number here, then that shows it’s a healthy core business because it is generating ample amount of cash. On the other hand, if we see a negative value here, then maybe the company has borrowed or sold assets to survive. 

After this, we have to analyze Investing Activities. So basically, if we see negative cash flow from Investing Activity, that does not mean that it is always bad. It means that the company may be expanding for expansions. Generally, in companies, cash outflow happens here. And if we see a negative number in Investing Activities, that does not always mean it’s a negative sign. On the other hand, if we see positive CFI—that is, Cash Flow from Investing Activity—then it could indicate asset sales, meaning the company has sold some assets. And it might be a red flag if it is very frequent. Positive CFI means the company is reinvesting. 

After this, we examine Cash Flow from Financing Activities. So under Cash Flow from Financing Activities, we check whether we see a positive number or a negative number. So basically, positive CFF means that the company is raising money via equity or loans. As we just discussed, if a company is issuing equity, then obviously there is cash inflow, and if it is taking loans, then again there is cash inflow. So here, positive CFF may be seen in these cases. 

If we talk about negative CFF, then if the company is repaying its loans, or the company has paid out dividends, then here we can see cash outflow, resulting in a negative CFF. Now remember here, if the company’s operating cash flow is negative and the company has been continuously borrowing, it is a kind of red flag. Okay? 

Now let’s look at an example of how we actually read a Cash Flow Statement. So here on your screen you can see a certain company ABC. Its Cash Flow Statement. If you look here, you can see that under Cash Flow from Operating Activities all the figures are shown in crores. 

So net profit before tax is shown as 500 crores. The depreciation is 80 crores. The interest the company has paid is 20 crores. Increase in the working capital is around 50 crores. 

So if you pay attention here, the cash inflows are obviously in terms of profitability, in terms of depreciation, and in terms of interest paid. Considering all this, if we calculate net cash from Operating Activities, then it comes out to around 550 crores. 

Look carefully. So, 500 crores is the net profit before tax. Depreciation is 80 crores. Interest paid is 20 crores. Increase in the working capital is 50 crores. So basically, what we are doing here is adding depreciation and interest paid, and subtracting the increase in working capital. And we are deriving 550 crores as net cash from Operating Activities. Okay? 

Now we examine Cash Flow from Investing Activities. So if you notice here, purchase of machinery—almost 200 crores worth of machinery has been purchased. This is a kind of cash outflow. Investment in a subsidiary—they have invested a little in a subsidiary which is around 100 crores. Here again it is a cash outflow. Proceeds from sale of assets—they have sold assets, and by selling assets, almost 50 crores of cash inflow has happened here. So net cash from Investing Activities, if you notice, is -250 crores, which has mostly gone into purchase of machinery and investment in the subsidiary. Okay? 

Now along with this, if we look at the record of Cash Flow from Financing Activities, they have issued new shares under which 100 crores inflow has happened. Because when they issued new shares, the people who bought shares, whose shares were allotted, their funds resulted in a kind of cash inflow. Loan repayment—around 150 crores has been repaid, which is going as cash outflow. Dividend they have paid, which is 50 crores, is again going as cash outflow. So here, net cash from Financing Activities is again a negative number, -100 crores. 

This Cash Flow Statement is actually giving me a fair idea of where the company has been investing, how the company has been taking care of its cash inflows and outflows. 

So in this video we learned that the Cash Flow Statement is a vital resource to understand where the real cash is going and from where the real cash is coming into the company. It focuses on the operating cash flow trends and it’s a great tool for making smart investing decisions. 

So that’s it in this video. We’ll meet again in the next video. 

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