For those new to financial analysis, distinguishing between cash flow statements and income statements can be challenging. While they may appear similar at first glance, these are distinct financial documents, each providing unique and essential insights into a company’s financial status.
A cash flow statement, in conjunction with a company’s balance sheet and income statement, offers critical financial information investors, financial analysts, and decision-makers require to evaluate a company. In contemporary lending business, bank cash flow statement analysis emerges as a meaningful process that determines how much cash is entering and leaving a business.
In this blog post, we dig deeper into understanding the crucial details about statement analysis and its key elements.
What is a Bank Cash Flow Statement?
A bank cash flow statement is a financial document that records a company’s cash inflow and outflow for a specific period. It is a fair reflection of a company’s ability to make purchases, pay bills, and how much cash it has in hand.
While a company’s income statement also offers important insights, it does not offer clarity into how much cash it has, its expenses, and its overall financial stability.
As mentioned earlier, while a bank statement isn’t the sole document that influences investors’ and lenders’ decisions, bank cash flow statements, combined with income statements and balance sheets, become an invaluable tool to determine a company’s financial stability and health.
Understanding Cash Flow Statement Analysis
Cash flow statement analysis stands for the process of calculating the amount of cash that has entered or left a business during the stipulated accounting period.
This is generally divided into three components, including cash flow from operations, cash flow from investments, and cash flow from financial activities.
Businesses rely upon these three statements to determine how much cash and where it is coming in or going out from. Companies can then take a call on whether their cash flow is in the right direction and aligned with their objectives.
Components of Cash Flow Statement Analysis
Let us take a look at the three important components of a cash flow statement that indicate the different ways cash can enter or leave the business.
1. Cash Flow from Operations
Cash generated from operations is the primary way of earning or spending money for most businesses. In short, by selling their products and services.
2. Cash Flow from Investments
As the name suggests, cash flow from investments refers to cash earned or spent on investments, including expanding your office, upgrading equipment, acquiring a company, etc.
3. Cash Flow from Financial Activities
Cash flow from financial activities indicates the cash earned or spent by a company to finance itself either via loans, owner’s equity, and more.
Cash Flow Statement Analysis Techniques
Now, let us dive deeper into understanding how businesses determine their cash flow. Most businesses either deploy the direct or indirect method to calculate how much cash they have and can work with.
Direct Method
The direct method only takes all the cash transactions into account, excluding all non-cash expenses, including amortisation and depreciation.
Indirect Method
The indirect method takes all the changes and adjustments to assets and liabilities into account, along with changes in cash flow due to adjustments made with cash expenses. Despite being more time-consuming and less accurate, the indirect method is preferred over the direct method as it includes all adjustments.
Analysing Cash Flow Statements: Key Components
Cash flow statements are the missing pieces of the puzzle between a balance sheet and an income statement that provide a comprehensive view of a company’s financial health. Companies also use it to ensure their receivables are converted to cash at the earliest.
It is worth noting that although a company may have a positive or a negative cash flow, one should only judge its financial health after going through other financial statements.
Here are the key aspects you must know before conducting an accurate cash flow statement analysis:
1. Debt Service Coverage Ratio
The measure of a company’s ability to pay off short-term liabilities is known as the debt service coverage ratio. However, it is also important to understand that just because a business has ample liquid assets, it does not necessarily indicate that it is thriving. For example, a company may currently have a lot of cash at its disposal due to mortgaging its future growth by selling long-term assets or incurring debt.
This is how the debt service coverage ratio is calculated:
DSCR = Net Operating Income/Debt Services
2. Free Cash Flow
Free cash flow determines a business’s true profitability and is an important observation that can be drawn from a cash flow statement analysis. It is one of the most important financial metrics as it gives an accurate idea of a business’s total cash on hand for use.
3. Unlevered Cash Flow
The unlevered cash flow, also known as a free cash flow to the firm (FCFF), highlights the amount of cash available to the business before considering interests and other types of financial obligations. The difference between levered and unleveled cash flow provides a clear understanding of whether a business is not exceeding certain debt levels.
Wrapping Up
Despite its drawbacks, cash flow statements offer significant clarity into a company’s financial stability and cash position. Investors, stakeholders, and financial analysts will refrain from making major decisions about a business without going through their cash flow statements.
Additionally, all the major decision-makers should go through their cash flow statements to ensure their business is on the right track financially and also mitigate risks in a timely and streamlined manner.
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