Cash Flow Statement Analysis

Cash flow statements start with net income and then add back non-cash expenses such as depreciation, which deduct from net income but don’t result in cash changing hands. Cash flow statements consist of three sections:

Operating Cash Flow, which is the cash in or out that is generated by normal business operations.

Cash Flow from Investing Activities, which is the cash in or out from capital equipment purchases, funding of acquisitions, and short term forms of investments.

Cash Flow from Financing Activities, which is the cash in or out from stock sales and buybacks and from borrowings or debt repayment.

You need consider only two items to do the analysis, operating cash flow and free cash flow.

Operating cash flow should be positive. A company isn’t profitable if it doesn’t report strong positive cash flow. How much is enough? At a minimum, operating cash flow should exceed the total net income (top line of the cash flow report) for the same year.

Free cash flow is operating cash flow minus money spent on capital expenditures and acquisitions (listed under investment activities). It is the money left over after a firm has run its basic operations and made the additional expenditures necessary to remain competitive and to continue growing. Free cash flow isn’t shown on the cash flow statement, so you’ll have to calculate it.

The best companies generate positive free cash flow, which means they have surplus cash they can use to pay dividends, buyback shares, or enter new businesses.

Many experts consider cash flow more important than reported earnings