Ever wondered why a company looks profitable on paper but still goes bankrupt?
Or why net income is positive, but cash is shrinking?
๐ The answer often lies in the Cash Flow Statement.
This guide will break down the basics of cash flow into three key categories: Operating, Investing, and Financing โ explained in plain English for beginner investors.
โ What Is a Cash Flow Statement?
The cash flow statement shows the actual movement of money in and out of a company.
- Income Statement (Net Income): accounting numbers, may include non-cash items
- Cash Flow Statement: real cash coming in and going out
๐ก Thatโs why cash flow is often considered more reliable than reported profits.
๐ The Three Pillars of Cash Flow
1๏ธโฃ Operating Cash Flow (OCF)
๐ Shows whether the company is making money from its core business.
Examples:
- Cash received from customers
- Salaries and supplier payments
- Taxes and interest income
โ Good Sign: Operating cash flow is consistently positive โ The business is healthy and generating real cash.
2๏ธโฃ Investing Cash Flow (ICF)
๐ Reflects how much the company invests for future growth.
Examples:
- Buying or selling equipment/facilities
- Acquiring or divesting subsidiaries
- Real estate purchases or sales
โ
Normal Pattern: Usually negative โ companies spend money to expand and prepare for the future.
โ ๏ธ Warning: If itโs too negative for too long, it could signal overinvestment.
3๏ธโฃ Financing Cash Flow (FCF)
๐ Shows how the company raises and repays capital.
Examples:
- Issuing bonds or borrowing from banks
- Paying dividends
- Repurchasing shares
- Repaying debt
โ Healthy Signs:
- Moderate borrowing, sustainable dividend payments
- Long-term balance between inflows and outflows
๐ Putting It All Together
Ideal pattern for a strong company:
| Category | Ideal Trend | What It Means |
|---|---|---|
| Operating Cash Flow | Positive | Earning from core business |
| Investing Cash Flow | Slightly Negative | Investing in future growth |
| Financing Cash Flow | Balanced | Controlled borrowing, steady dividends |
Risky patterns to watch out for:
| Category | Red Flag | Risk |
|---|---|---|
| Operating Cash Flow | Consistently negative | Core business losing money |
| Investing Cash Flow | None or excessive | No growth, or overexpansion |
| Financing Cash Flow | Heavy borrowing | Debt risk increasing |
๐ง Practical Tips for Investors
- Donโt just trust net income โ compare it with operating cash flow.
- If net income is positive but operating cash flow is negative โ possible โpaper profits.โ
- Too much investment spending + weak operating cash flow = cash crunch risk.
- Check financing cash flow with the interest coverage ratio to assess debt sustainability.
โ Quick Summary
| Section | Key Question | Healthy Sign |
|---|---|---|
| Operating Cash Flow | Is the core business profitable? | Positive cash flow |
| Investing Cash Flow | Is the company preparing for growth? | Reasonable negative flow |
| Financing Cash Flow | Is capital well-managed? | Balanced and sustainable |
๐ Final Thoughts
The cash flow statement is the most honest report in financial statements.
It reveals whether profits are backed by real money.
๐ Strong companies not only show high earnings but also positive, sustainable cash flows.
By combining PER, ROE, and other valuation ratios with a clear view of cash flow, youโll see the true financial health of a business.
๐ Disclaimer
This article is intended for educational purposes only. It does not constitute financial, investment, or legal advice. All investment decisions involve risks, and readers should conduct their own research or consult with a licensed financial advisor.
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