When it comes to judging a company on the basis of its historical data, the chances that you may flip through the cash flow statement are quite slim. In fact, the traditional mindset of delving deep into the profit and loss account and the balance sheet inevitably emerges as an indispensable tool to see the performance of a company.
However, though this information is crucial and cannot be done away with, a study of the cash flow statement of a company can be quite enlightening in terms of its growth path, strength, and a prominently clear and vividly insightful trend that a company follows when it comes to channelising cash it gets access to.
Cash flows can be divided into three major sources: operations, investing, and financing. A mature company has positive cash flows from its operations, while its cash flows from investing and financing are negative or negligible, considering its reliance on generating cash in itself rather than from an external source. On the other hand, a young growing company would depend more on financing and the ensuing investment related to the financing. Hence, it maybe a possibility that cash flows from its operations maybe negative, whereas, cash flows from investing and financing maybe positive.
This is the concluding part of the article on the insights involved in examining cash flow of a company. Cash flows determine financial health, trends, and developments of a company.
Though we can classify a company based on the sources and uses of cash flows, more data is needed to put this information in perspective. What is the trend in the sources and uses of cash flows? What market, industry, or company-specific events affect the company’s cash flows? How does the company being analysed compare with other companies in the same industry in terms of the sources and uses of funds?
In fact, a closer look at the cash flows of a company also gives a deeper understanding of how much the company is self-reliant and how much it is dependent on external financing. Consider ITC, which had growing sales and net income from 2003 to 2007. (See charts). You can see that the company’s net profit and sales grew each year. You get additional information by looking at the cash flows and their sources that the growth in ITC was supported by both internally generated funds and, to a lesser extent, through external financing.
Hence, ITC’s pattern of cash flows suggests that it is a mature company that has become less reliant on external financing, funding most of its growth in recent years with internally generated funds.
Hence, cash flows not only throw light on the path taken by a company to reach where it is at now but also to an extent it could take in the immediate future.
However, it is important to look at the cash flows statement of a company apart from the crucial profit and loss, balance sheet and other ratios of a company.
Because the cash that goes into a company (shareholder’s money and other mode of infusion), its use, and manipulation and re-investment, has a bearing on the future growth of the company.
You must also take into account the fact that the cash flows statement must be considered in conjunction with the profit and loss, balance sheet, and other investment parameters to get a comprehensive picture of a company’s growth.