5 ways to analyse a cashflow statement, and why a strong understanding of your statement of cash flows is vital

Due to the importance of cash and cash management, information relating to explicit movement of cash needs to be included in the financial statements. The statement of cash flow (or cashflow statement) presents all the movement of money of an entity for a given time period. Users of financial statements - such as business managers or owners - will analyse cash flows for short-term decision making.

Breaking down the cashflow statement into groups of cash flows

1. Operating activities – These are the main revenue-producing activities of the entity that are not investing or financing. Operating cash flow includes cash received from customers and cash paid to suppliers and employees. It does not include depreciation and amortisation or recognised income which has not yet been received or expenses which have not yet been paid.
2. Investing activities – These activities relate to the buying and selling of fixed assets and the increase or decrease of investments that are not considered to be cash equivalents.
3. Financing activities – Looks at how a company is funded, either through debt or equity. Were there additional loans acquired or issued shares. This is useful to investors wishing to predict any future claims on the cash of the entity.

Analysing your statement of cash flows

1. Cash flow to total debt – This cash flow ratio measures the cash flow generated from trading activities in relation to total debt. It is calculated as follows: cash flows from operations divided by total debt.
2. Quality of earnings – This ratio analyses the percentage of income that is due to higher sales volume or a reduction of costs. It can be calculated as follows: operating cashflows divided by profit.
3. Acid test ratio – This ratio measures the ability of an entity to pay its current liabilities with current assets without having to sell its inventory. However, it might not give a reliable picture if accounts receivable take longer than usual to recover. It is calculated as follows: current assets (excluding inventory) divided by current liabilities.
4. Interest cover – This ratio measures the ability of the entity to cover its finance costs. It is calculated as follows Earnings before Interest and Tax (EBIT) divided by interest. On a cash basis we can calculate it as follows, cash generated from operations divided by interest. This ratio shows the number of times operating profit or cash can cover interest costs.
5. Return on Assets – This ratio speaks to the investment made into the assets and what is the return of that investment. This ratio is calculated as follows: EBIT divided by total assets.

Speak to us about your statement of cash flows and understand what it means for your business.