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5 Tips to Start Writing a Cash Flow Statement Analysis

Cash flow statement analysis basics

The cash flow statement analysis is used to get the details of a company’s cash inflows and outflows. The cash flow statement shows where a company’s cash inflows are being generated and where its cash outflows are being spent over a specific period of time and is important for analyzing the liquidity and long term solvency of a company. Cash flow statement preparation uses cash basis accounting rather than accrual basis accounting which most companies use for balance sheets and income statements. It is important to remember this as a company may accrue accounting revenues but may not actually receive the cash.

The cash flow statement consists of three components:

  1. Cash flow from operating activities: This is the net amount of cash coming in or leaving from the day to day business operations of a company. Essentially it is the operating income plus non-cash items such as depreciation report added. Cash flow from operations is an important measurement as it indicates the viability of a company’s current business plan and operations. Cash flow from operations must be cash inflows for a company to be solvent and provide for the normal outflows from investing and finance activities.
  2. Cash flow from investing activities: This includes the outflow of cash for long term assets such as land, buildings, equipment, and other assets and the inflows from the sale of assets, businesses, securities, and similar assets. The majority of cash flow investing activities consist of cash out flows because most entities make long term investments for operations and future growth.
  3. Cash flow from finance activities: This consists of the cash out flow to the entities investors such as interest to bondholders and dividends to shareholders and cash inflows from sales of bonds or issuance of stock equity. The majority of cash flow finance activities are cash outflows since most companies don’t issue bonds and stocks very often.

Tips for preparing a cash flow statement analysis

When you prepare cash flow statement analysis on a company there are some simple but useful calculations that can tell you quite a bit about the company. Cash flow can often tell more about the strength of a company than a balance sheet. Here are 5 useful calculations that reveal plenty in a cash flow statement analysis:

  1. Operating Cash Flow/Sales Ratio: This ratio compares a company’s operating cash flow to its net sales or revenues, which gives investors an idea of the company’s ability to turn sales into cash. Basically it tells you how much cash you get for every dollar of sales. OCF/sales ratio = Operating cash flow/Net sales
  2. Asset Efficiency Ratio: You can use this ratio to show you how well a company uses its assets to generate cash flow. Asset efficiency ratio = Operating cash flow/Total assets
  3. Current Liability Coverage Ratio: This is a ratio that gives you an idea about a company’s debt management practices. The higher the number you get for the calculation then the better. If the drops below 1, then operating cash flow is unable to pay the current liabilities. Operating cash flow / Current liabilities = Current liability coverage ratio
  4. Long Term Debt Coverage Ratio: The higher the number is from this calculation then the more money there is available to pay down long-term debt Operating cash flow / Long term debt =Long term debt coverage ratio
  5. Interest Coverage Ratio: This ratio shows a company’s ability to make the interest payments on its entire debt load. A highly leveraged company with a large amount of debt will have a low multiple. A company with a strong balance sheet will have a high multiple. If the interest coverage ratio is less than 1, then the company has a high risk of defaulting on payments. (Operating cash flow + Interest paid + Taxes paid) / Interest paid = Interest coverage ratio

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