Some Important Points Regarding Cash Flow Analysis Applied by a Company

When a company reports results in the market, most of the attention of analysts and the media usually focuses on variables related to the income statement, mainly sales and earnings per share. But business cash flow can be as much or more important than accounting earnings, and learning to interpret this information is an important key. The key is needed by everyone willing to choose an investment company like Invezz.com.

Cash flow versus profit

Accounting earnings basically include different items that make up the income and costs of the business. This is obviously a very important indicator, although it does not necessarily tell us everything we need to know. For example, if a company has increased its sales and profits, this does not guarantee that cash flows are increasing.

These are just a few important points to keep in mind, and cash flow analysis is both an art and a science. However, the central point is that cash is the lifeblood of a business, and cash flows often show us information that goes beyond the income statement.

Many high growth companies need to finance their customers, or invest increasing sums of money in inventories to meet demand. Therefore, it is possible that the business is consuming cash, even if the income statement shows encouraging data in terms of sales and profits.

The difference for the investor can be decisive: a business that consumes cash may need external financing through debt issuance, which has great implications in terms of risk. It is also possible that the company needs to issue new shares to obtain financing, and this will dilute the value of the shares over time, negatively affecting the shareholder’s return. Unlike accounting results, cash flows take into account cash receipts and outflows, which can provide a much more transparent picture of the financial evolution of the company. For example, if a company makes sales but does not charge them in a certain period, the income statement will reflect the sales and earnings corresponding to that transaction. Instead, cash flow makes it clear that the sale has been made, but cash income did not materialize because the company is financing the transaction. In some cases, taking this difference into account may be decisive.

Operating cash flow

The main component of a cash flow statement is the operating cash flow. It reflects the amount of money the business produces or consumes based on its operations in a given period. In general, it includes many of the variables that are included in an income statement, such as sales revenue and cost items such as gross costs and operating expenses.

On the other hand, there are also some important differences between the operating cash flow and the accounting earnings of the business. First, the inventory increases consumes cash, while a reduction in this inventory releases cash flows. What need to remember is that if the company is financing customers, this reduces the operating cash flow in the period.