Why Is Cash Flow Important in Investing?

A company can report a profit and still run into cash problems. That’s why cash flow matters. 

A cash flow statement is one of the main financial statements that publicly traded companies typically prepare and publish for investors to review. The cash flow statement reports the cash coming in and out of the business over a given period and, along with the other financial statements, can help readers better understand a company’s operations, financial activity, and reported cash movements. 

Cash Flows Importance

Although news headlines are more likely to focus on a company’s profits, the cash flow statement can reveal trends hidden behind sales and profit numbers. A company might achieve profitability by making lots of sales on credit. However, if it’s unable to collect payments from customers, eventually, the company could run into trouble.

What is a cash flow statement?

A cash flow statement is a financial statement that shows the cash going in and out of a business over a set period. An accounting department keeps track of every transaction that involves cash, such as receiving money when a client pays an invoice or sending money out to make payroll or meet a loan payment.

Cash flow is calculated by adding cash inflows to the company and subtracting cash outflows. If a company brought in more cash than it paid out, it had positive cash flow over the period. 

What is on a cash flow statement?

1. Operating activities: This section summarizes cash inflows and outflows involved with running the business. 
2. Investing activities: This section shows cash inflows and outflows from long-term investments in assets such as land, buildings, and equipment, or from investments the company holds in financial assets, such as another company’s bonds or stock. 
3. Financing activities: This section generally shows inflows and outflows to or from investors and lenders. 

Analyzing a Cash Flow Statement

By analyzing a cash flow statement, readers can evaluate how a company generates and uses cash across its operations, investments, and financing activities. Additionally, investing cash flow shows how a company allocates funds for growth. High capital expenditures (capex) may reflect investment in facilities, equipment, or growth initiatives, while frequent asset sales may warrant further review of a company’s financial activities.

Moreover, cash flow financing reveals how a company raises and repays capital: debt issuance and dividend payments may provide additional context about how a company finances its operations and allocates capital.

Companies can exhibit different cash flow patterns depending on their industry, business model, and stage of development. Positive operating cash flow, capital investments, debt issuance, asset sales, and shareholder distributions may provide additional context when evaluating a company’s reported financial activity.

Factors commonly reviewed when analyzing cash flow statements include:

• Consistently positive operating cash flow
• Strategic capex
• Balanced financing activities, such as debt repayments and shareholder returns

Areas that may warrant additional review include:

• Declining or negative operating cash flow

• Excessive reliance on external financing
• Frequent asset sales for liquidity
• High cash burn rate

Free cash flow, debt levels, and cash flow trends are commonly reviewed alongside other financial metrics when evaluating a company’s financial position. These measures should be considered in the broader context of the company’s industry, business model, and overall financial statements.

Mark Notes

Reading a cash flow statement can feel confusing to new investors at first. You can start by looking at the final result: Did the company increase or decrease its overall cash position? Then, look at why. While an increase in overall cash might look good at first, it could be a concern if the inflow came from issuing debt, but the company had negative operating cash flow. 

Reviewing operating, investing, and financing cash flows can provide additional context about how a company generates, invests, and uses cash over time. Cash flow analysis is often used alongside income statements and balance sheets to develop a broader understanding of a company’s reported financial results.

Before reading this post, were you more familiar with revenue, earnings, or cash flow? 

This article is for general informational and educational purposes only. It is not intended as financial advice, investment guidance, or a recommendation to buy or sell any security. The content reflects publicly available information and broad market commentary. Readers should conduct their own research and consult a licensed financial professional before making investment decisions.