How to Read a Company's Cash Flow Statement Before You Invest

Key Takeaways

1. A cash flow statement shows how much cash a company actually brought in and spent during a period, which profit figures alone may not show.
2. It is divided into three parts: operating, investing and financing activities.
3. Steady positive cash flow from operating activities can be a useful sign when assessed alongside reported profit and the company’s business model. 
4. Free cash flow is commonly calculated as operating cash flow minus capital expenditure. It helps assess the cash remaining after capital spending, which may be used for purposes such as debt repayment or dividends.
5. Reading the cash flow statement together with the profit and loss statement and balance sheet gives a fuller picture in fundamental analysis.

A company can report rising profits and still struggle to pay its bills. This can happen..

Profit is an accounting figure, while cash flow tracks the cash and cash equivalents moving into and out of the business. The cash flow statement helps investors understand how a company generates and uses cash before deciding whether to invest in its stock.

Through this blog, you can understand how to read a cash flow statement as part of your fundamental analysis.

What Is a Cash Flow Statement?

A cash flow statement is a financial statement that records the cash a company received and paid during a specific period, usually a year or half-year.

Companies that follow Indian Accounting Standards (Ind AS) prepare their cash flow statements in accordance with Ind AS 7, Statement of Cash Flows. Listed companies publish financial statements, including cash flow information where required, in their financial reports and exchange filings.

While the profit and loss statement tells you whether a company earned a profit on paper, the cash flow statement helps you see how much of that profit turned into actual cash.

The Three Sections of a Cash Flow Statement

Every cash flow statement is split into three parts, each answering a different question about the business.

1. Cash Flow From Operating Activities

This section shows the cash generated from the company's core business, such as selling products or services.

Many companies use the indirect method to report operating cash flow. It starts with profit or loss and then adjusts for non-cash items like depreciation, along with changes in working capital such as receivables, inventory and payables.

This section is important because it shows whether the company’s main business generates cash. Consistent positive operating cash flow can reduce the need to borrow for day-to-day operations, although the company's wider financial position also matters.

2. Cash Flow From Investing Activities

This section covers cash spent on or received from long-term assets, such as machinery, plant and equipment, acquisitions or investments.

A negative figure here is not always a bad sign, as a growing company often spends on new equipment, capacity or acquisitions. Consider whether the spending fits the company's plans and whether its operating cash flow and financial position can support it.

3. Cash Flow From Financing Activities

This section shows cash moving between the company and its lenders or shareholders. It includes fresh borrowing, loan repayments, dividend payments, share buybacks and money raised by issuing new shares.

Borrowing year after year to fund daily operations deserves a closer look.

Here's a simple way to read the three sections together:

Key Signals to Check Before You Invest

Compare operating cash flow with net profit

If net profit keeps on increasing while cash flow from operating activities remains flat or declines, look into the reasons. The difference may be related to receivables, inventory, other working capital changes or non-cash items. Compare both figures over several years to understand the trend.

Calculate free cash flow

Free cash flow is commonly calculated as operating cash flow minus capital expenditure. It helps investors assess  how much cash remains after capital spending. This cash may support business needs, debt repayment or dividends, depending on the company's other commitments. You can read more about it in our blog on why free cash flow matters in evaluating a company.

Look at the trend, not one year

A single weak year may have a valid reason. Reviewing several years of cash flow data can help you understand whether the pattern is temporary or continuing. 

These signals usually work for non-financial companies. For banks and NBFCs, lending and deposits are part of the core business, so their cash flow statements need to be read differently.

Check how dividends are funded

Dividends supported by operating cash flow may be  more sustainable than dividends funded through borrowing, but operating cash flow alone doesn’t establish whether a dividend is sustainable.

Common Doubts About Reading a Cash Flow Statement

Is negative cash flow always a warning sign?

No. Negative investing cash flow may mean the company is spending on equipment, capacity or acquisitions. However, negative operating cash flow over several years deserves closer attention, especially if the company is struggling to fund its day-to-day operations.

Can I skip the cash flow statement if the company is profitable?

It is not advisable. Profit can include non-cash items and sales made on credit. The cash flow statement shows whether money is actually coming in.

Where can I find a company's cash flow statement?

You can find it in the company's annual report or stock exchange filings. Our guide on how to use annual reports for investment decisions explains how to go through these reports.

Is the cash flow statement enough for fundamental analysis?

No single statement gives the full picture. Fundamental analysis works well when you read it along with the balance sheet and profit and loss statement.

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Final Thoughts

A cash flow statement helps you understand how a company generates and uses cash. Reviewing  its three sections and tracking free cash flow over several  years can help you assess the company’s financial position.

Make it a regular part of your fundamental analysis before you invest in any stock.

Frequently Asked Questions (FAQ)

1. What is a cash flow statement in simple terms?

It is a report that shows how much cash a company received and spent during a period, divided into operating, investing and financing activities.

2. Which section of the cash flow statement matters most?

Cash flow from operating activities is often a key section because it shows whether the company's main business generates cash. However, investing and financing activities also provide important information about the company's financial position.

3. What is free cash flow?

Free cash flow is commonly calculated as operating cash flow minus capital expenditure. It helps assess how much cash remains after capital spending and may be available for purposes such as debt repayment or dividends, depending on the company's other commitments.

4. Why can profit and cash flow be different?

Profit and cash flow can differ because profit includes non-cash expenses, such as depreciation, and may include sales for which payment has not yet been received. The timing of payments and changes in working capital can also affect cash flow.

5. Is fundamental analysis useful for short-term trading?

Fundamental analysis is mainly used by long-term investors. Short-term traders often rely more on price charts and technical indicators.