Positive cash flows, negative cash flows, and healthy cash flow statements

 

In financial accounting, a statement of cash flows is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing and financing activities [source].

A cash flow statement shows the cash inflows, cash outflows and cash balance over an accounting period. It is always good to look at this statement to spot tell-tale signs about your company’s health – good and bad. Monitoring and reviewing past and current cash flow statements firstly helps you understand your real estate business’ cash flows, and secondly it helps you understand where you need to make changes in the cash management for positive cash flows. This blog talks about when you can smile about a cash flow statement – when it is healthy.

Sections of a Cash Flow Statement:

As mentioned earlier, the statement is broken into three sections: operating, investing and financing activities. At the bottom of each section one can find the total cash flow for that category. Positive cash flow means the business spent less in that area than the cash it generated for that activity, and the reverse denotes negative cash flow.

Operating Activities

This reflects the cash flows from the core business activities – sales, purchases, building inventory, advertising etc. etc. That means this is the money to re-invest and grow the business. This section should always show a positive net cash flow, and the amount must consistently increase over time, because it shows that the company has sufficient money to cover its running costs. Failing this the business will have to reach out to external funding sources, which can’t sustain the business long term.

Investing Activities

This section shows the cash flows used to buy or sell long-term assets (e.g. property or equipment). The paradox here is that a steadfast business methodically invests in assets, typically buying more than it sells, and, therefore, will have a negative net cash flow. Investment activities mean that the business is committing to new assets to expand its dimensions, replace old equipment and accoutrements, and stay abreast of new technology.

Financing Activities

This section expresses cash used in retiring external financing (e.g. debt, stock, dividends etc.). Here again it might seem contradictory but financing activities should more often reflect a net negative cash flow because that would mean that it is using the money from operating activities to pay dividends and external financers. When a business is doing that it means it is cycling its cash inflow well. However, occasionally a good business may show a net positive cash flow. This could show that the money is coming in from investors or creditors to organically expand the business.

As is evident from the three different sections, it is clear that negative cash flow doesn’t necessarily mean that the company’s performance was bad. Sometimes it could just mean differed billing as opposed to the lack of a sale. And positive cash flow in the wrong place can also have repercussions. It just has to be under the right category.

So use these pointers as a guide to gauge whether cash flows are healthy, or as a trip wire to review them when they aren’t!

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