Cash flow statements are one of the most information statements available to small businesses. While analyzing cash flow statements are best done over a period of time, their usefulness goes beyond long-term projections. These statements are less likely to be manipulated when compared to net income or operating income statements.
Cash flow statements offer several helpful metrics such as free cash flow and cash flow to debt. These metrics are useful in determining the overall health of your business and offer a somewhat more in-depth glimpse at your business’s financials.
Sections of a Cash Flow Statement
Initially, it is important to understand how your business acquires and spends cash. The cash flow statement is divided into operations, financing, and investing sections to delineate the influx and output of cash.
- The Operating Activities section of the cash flow statement indicates how much cash originates from the sales of your business’s goods and services. Overall, potential business investors tend to prefer a positive net cash flow from Operating Activities. It’s important to watch out for a gap that widens over time between your business’s cash flow from Operating Activities and reported earnings. If your net income is higher than cash flow, this is a likely indicator that your business is slowing or speeding its booking of costs or income.
- The Investing Activities section of the cash flow statement reflects the amount of cash your business has spent on capital expenditures. These expenditures are typically new equipment or any needed items that keep your business running. It may also include monetary investments and business acquisitions. In general, your business should strive to re-invest capital back into the business at the same rate of depreciation expenses each year.
- Finally, the Financing Activities section of the cash flow statement reflects your business’s cash that is associated with external financing activities. Typical sources of inflow cash would be funds raised by selling private stock, bonds, or bank loans. However, servicing a debt on a bank loan will likewise show up as a cash expenditure, along with any dividend payments or stock repurchases.
Free Cash Flow
Using cash flow statements to analyze your business’s Free Cash Flow allows you to determine how much cash is available from your operating cash flows after taking into account capital expenditures that are required to maintain your business’s production capacity.
Free Cash Flow is calculated as: (Operations Cash Flow – Capital Expenditures Required to Maintain Current Growth).
If you are unable to ascertain your business’s capital expenditures required to maintain current growth, you can still calculate your Free Cash Flow by using total capital expenditures.
Free Cash Flow is an important metric as it essentially measures your business’s financial flexibility. Typically, the higher a business’s Free Cash Flow, the more flexibility the business is when strategic investment opportunities are present. Additionally, many analysts consider Free Cash Flow a crucial metric in sizing up a business’s growth and profit potential over time.
Cash Flow to Debt
Another useful metric that can be computed from cash flow statements is cash flow to debt. This metric is another way of allowing a business to determine whether they are generating sufficient cash flows to service their existing debt payments. This is typically done by expressing operational cash flows as a multiple of debt offers. Using this metric, you can calculate your business’s cash flows to current debt maturities, which is a good indicator of whether your business generates enough cash to pay off debt that matures within one year. This is calculated as follows: (Operational Cash Flow \ Current Debt Maturities).
Additionally, cash flow statements also allow you to calculate your business’s cash flow to total debt ratio. This ratio is commonly used by credit rating agencies when evaluating your business’s overall credit. This ratio is calculated as follows: (Operational Cash Flow \ Total Debt).