We know the purpose of a balance sheet and income statement and we have already discussed quite a few ratios relating to income statement and balance sheet. Cash flow statement is another important component of the annual report of the company which you have to clearly understand because a business can do well only if they have healthy cash flows.
Profits in the income statement are not equal to the cash flows that come to a company. A company might have components such as account receivable, accounts payable etc which will make the profits differ from cash. As per the accounting standard that we follow(accrual form), companies realize profits in the income statement if the transaction is complete and not when the cash flows occur.
Following are three forms of cash flows to a company :
  • Operating Cash Flow: This is the most important component of the cash flow statement. Operating cash flow is nothing but the cash flow which comes from the day to day business revenues and expenses. The operating cash flow and profit should be following each other (not an exact match, but at least in the direction and in magnitude. For example if profits have increased by 100 crore and the operating cash flow hasnít increased at all then it is a big concern).
  • Investing Cash flow: A growing company will generally have a negative investing cash flow because the cash goes out of the company for making big investments. The idea here is that if a company goes on to invest a lot in the current year then it has to realize it as operating cash flow in the future years. Be a little careful about companies if they have a positive investment cash flow. It can be either because they are selling of their some of the investments (shares in subsidiary etc) for profits. This is a positive thing. But if the companies are selling off their machinery and generating positive investment cash flow then it is a matter of concern.
  • Financing cash flow: It is the cash flows which come into a company because of the various financing options like equity, debt etc. Some years, this will be positive and in some years this will be negative depending on the source and use of financing.