Cash Flow

60-Plus Delinquencies

What is cash flow

Cash flows are the net amount of cash and cash equivalents transferred into and out of a business. At the most fundamental level, a company’s ability to create value for its shareholders is determined by its ability to generate positive cash flows or, more specifically, to maximize free cash flows over the long term.


Understanding cash flows


One of the most fundamental objectives of financial reporting is the assessment of amounts, timing and uncertainty of cash flows. Understanding the cash flow statement – which reports on operating cash flow, investment cash flow and cash flow financing – is essential to assess the overall liquidity, flexibility and financial performance of a company.

A positive cash flow indicates that a company’s liquid assets are increasing, allowing it to settle debts, reinvest in its business, make money for shareholders, pay expenses and protect itself against future financial challenges. Companies with high financial flexibility can benefit from profitable investments. They also do better in a downturn, avoiding the costs of financial distress.

Even profitable businesses can fail if operating activities do not generate enough cash to remain liquid. This can happen if profits are tied up in accounts receivable and inventory, or if a business spends too much on its capital expenditures. Investors and creditors therefore want to know if the company has enough cash and cash equivalents to settle its short-term liabilities. To see if a company can honor its current liabilities with cash generated from its activities, analysts examine debt service coverage ratios.

But liquidity speaks volumes. A business can have a lot of cash because it is mortgaging its future growth potential by selling its long-term assets or by contracting unsustainable debt levels.

Free movement of capital

To understand the true profitability of the company, analysts look at free cash flow (FCF). It is a very useful measure of financial performance – which tells a better story than net income – as it shows the money left in the company to grow the business or return to shareholders after paying dividends , bought back shares or repaid a debt.

Free cash flow = cash flow from operations – capital expenditure – dividends (although some companies do not do so because dividends are considered discretionary).

To measure the gross free cash flow generated by a business, use free cash flow without leverage. This is the cash flow of a business before taking into account interest payments and indicates the amount of cash available to the business before taking into account financial obligations. The difference between leverage and non-leverage free cash flow shows whether the business is overexploited or operating with a healthy amount of debt.

Example from the real world

Below is a reproduction of the Walmart Inc. (WMT) cash flow statement for the quarter ending April 30, 2020. All amounts are in millions of US dollars.

Cash flows from operating activities:
Consolidated net income 3,283
Loss (profit) from discontinued operations, net of tax
Income from continuing operations 3,283
Adjustments to reconcile consolidated net income with net cash from operating activities:
Depreciation and amortization 2,319
Deferred taxes (159)
Other operating activities 239
Variations in certain assets and liabilities:
Receivables, net 782
inventories (1,475)
Accounts payable (319)
Liabilities payable (919)
Income taxes payable 695
Net cash provided by operating activities 4,446
Cash flows from investing activities:
Payments for property, plant and equipment (2,203)
Proceeds from disposal of tangible capital assets 68
Other investment activities 22
Net cash used in investing activities (2,113)
Cash flows from financing activities:
Net change in short-term borrowings (741)
Proceeds from the issuance of long-term debt 43
Long-term debt payments (915)
Dividends paid (1,579)
Purchase of company shares (280)
Dividends paid to non-controlling interests (69)
Purchase of interest without control (70)
Other fundraising activities (84)
Net cash used in financing activities (3,695)
Effect of exchange rates on cash and cash equivalents (14)
Net increase (decrease) in cash and cash equivalents (1,376)
Cash and cash equivalents at the start of the year 9.135
Cash and cash equivalents at the end of the period 7,759

Let’s start by seeing how the cash flow statement integrates with other components of Walmart’s financial statements. The last line of the cash flow table, “cash and cash equivalents at the end of the period”, is the same as “cash and cash equivalents”, the first line under Current assets on the balance sheet. The first figure in the cash flow statement, “consolidated net income”, is the same as “income from continuing operations” in the income statement.

Since the cash flow table only includes liquid assets, it adjusts operating profit in order to achieve operating profit, which is presented in the form of cash and cash equivalents. Depreciation is shown on the balance sheet to give a realistic picture of the lifetime value of the assets. However, operating cash flows are considered at their nominal value, so these adjustments are reversed. Meanwhile, non-cash assets are deducted: inventory, for example. Investments which appear on the assets side of the balance sheet are deducted because they were probably paid in cash. The statement also takes into account debt repayments, dividends and currency effects. (For a related reading, see “Cash flow and depreciation effect”)

The main point to remember is that Walmart’s cash flow was negative (a decrease of $ 1.38 billion) for this quarter, but it’s not necessarily a bad thing as long as it maintains sufficient reserves to manage short-term liabilities and fluctuations in its business. (For a related reading, see “Is it possible to have a positive cash flow and a negative net profit?”)

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