The cash flow statement is one of the most revealing documents of a firm’s financial statements, but it is often overlooked. It shows the sources and uses of a company’s cash, both incoming and outgoing. Various sections of a company’s cash flow statement contribute to the overall change in the company’s cash position. Cash flow from investing activities is one of three primary categories, along with operating and financing, in the cash flow statement.
Key Takeaways:
- The cash flow statement shows the sources and uses of a company’s cash.
- Cash flow from investment activities shows the flow of cash from activity in financial markets, operating subsidiaries, and capital assets.
- A negative overall cash flow is not necessarily a bad thing because the company may be investing in capital assets for future gains.
Cash Flow From Investing Activities
Analyzing the cash flow statement is extremely valuable because it provides a reconciliation of the beginning and ending cash balance on the balance sheet. Keep in mind, though, that this analysis is difficult for most publicly traded companies because of the thousands of line items that can go into financial statements. But here are a few things you can consider.
A firm may have a negative overall cash flow for a given quarter. If the company cannot generate positive cash flow from its business operations, a negative overall cash flow is not necessarily a bad thing.
An item on the cash flow statement belongs in the investing activities section if it is the result of any gains (or losses) from investments in financial markets and operating subsidiaries. An investing activity also refers to cash spent on investments in capital assets such as property, plant, and equipment, which is collectively referred to as capital expenditure (CapEx).
Cash Inflows and Outflows
The following is a look at some of the cash inflows that may arise from a firm’s investing activities:
- Proceeds from disposal of property, plant, and equipment
- Cash receipts from the disposal of debt instruments of other entities
- Receipts from sale-of-equity instruments of other entities
Here are some of the outflows that may come from a company’s investing activities:
- Payments for acquisition of property, plant, and equipment
- Payments for the purchase of debt instruments of other entities
- Payments for the purchase of equity instruments of other entities
- Sales/maturities of investments
- Purchasing and selling long-term assets and other investments
Firms with excess capital or financial institutions such as banks and insurance companies will report the buying and selling activity from their investment portfolios in the investing activity portion of the cash flow statement.
The investing section of the cash flow statement needs to be analyzed along with a firm’s other financial statements. Reviewing CapEx, acquisitions, and investment activity are some of the most important exercises to see how efficiently a company’s management is using shareholder capital to run its operations.
Reading a Company’s Cash Flow Statement
A simple cash flow (of investing activities) for restaurant chain Texas Roadhouse (TXRH):
You’ll notice that the main investing activity for Texas Roadhouse was CapEx. Texas Roadhouse is growing briskly and spends plenty on CAPEX to open new restaurant locations across the U.S. In its 10-K filing with the Securities and Exchange Commission (SEC), the company details that it spends money to remodel existing stores and build new ones, as well as to acquire the land to build on. Overall, CapEx is an extremely important cash flow item that investors are not going to find in reported company profits.
The company also strategically bought franchises and spent $4.3 million in 2012 doing so. Sometimes it may sell restaurant equipment that is outdated or unused, which then brings in cash instead of being an outflow like other CapEx. This activity amounted to just over $1 million in 2012.
Net property and equipment for Texas Roadhouse increased by around $34.4 million between 2011 and 2012. Of this amount, the capital expenditure was capitalized (not expensed) on the balance sheet, net of depreciation. The other costs were expensed and reflected on the income statement. As for the nearly $4.3 million spent to buy out the franchised restaurants above, here is where it was allocated across the balance sheet:
For a public company, it’s going to be nearly impossible to use the original balance sheet and cash flow statements to determine each item down to the specific dollar amount. With the help of the notes to the financial statements (the above is from Texas Roadhouse’s notes on acquisitions), an interested party can get a good idea of the major items on the investing portion of the cash flow statement and what they mean for a firm’s financial health.
Significance of Cash Flow Statements
A firm can suffer from spending unwisely on acquisitions or CapEx to either maintain or grow its operations. A guide for CapEx is how it relates to depreciation and amortization, which can be found in cash flow from operations on the cash flow statement. This represents an annual charge on past spending that was capitalized on the balance sheet to grow and maintain the business.
For Texas Roadhouse, this amounted to $46.7 million in 2012. The fact that CapEx was nearly double this amount demonstrates that it is a growth firm. But there was little worry about its financial health because it had minimal long-term debt (other than capital leases) and generated an impressive $146 million in operating cash flow for the year to easily cover CapEx and $29.4 million in stock buybacks for the year (cash flow from financing activity).
What Are the 3 Types of Cash Flow Statements?
The three types of cash flow statements are the cash flow from operating activities statement, cash flow from investing activities statement, and cash flow from financing activities statement. The first highlights a company’s daily operations. The second is related to cash flow from long-term investments while the last one relates to financing activities, such as the sale of shares to investors.
What’s the Formula for Free Cash Flow?
To calculate free cash flow, subtract a company’s capital expenditures from its cash from operations. You can find both of these figures on the cash flow statement section of the company’s financial statements.
How Can my Company Improve Its Cash Flow?
There are several ways you can improve your company’s cash flow. Consider leasing rather than buying. Leasing allows you to pay for property and equipment in smaler payments rather than with a lump sum. Another way to boost your cash flow is to ask for payments immediately rather than waiting to send out your invoices. If all else fails, consider raising your prices. But do so judiciously instead of doing so at an alarming rate.
The Bottom Line
Cash flow statements outline the cash coming in and out of a company during a specific time. There are three different cash flow statements: cash flow from operations, from financing, and investing activities. Cash flow statements can be used with other key financial reports to help you understand whether a company is financially healthy and is a sound investment.