How is Your Company Spending its Money

A company has three major activities which cause money to flow to and from the company. The three activities are operation activities, investing activities, and financing activities. Each type of activity has specific implications for the financial health of the company. Conveniently, the cash flow statement is divided up into the cash flows by each type of operating activity they were generated by. But first, let’s take a look at what makes up the different types of activities.

Operating Activities

The first financial activity that appears on a cash flow statement is operating activities. Operating activities are the day to day operational activities of the company. Things like ordering inventory, cash from sales, paying wages and other typical day to day revenues and expenses all make up operating expenses. This is usually the section that makes up the largest cash flow as these expenses and revenues are usually the primary focus of a business.

Investment Activities

The next activity that appears in the statement of cash flows is the investing activities. This basically follows the money that changes hands when buying and selling capital. Any sort of land, building, or equipment purchases or sales are grouped into this activity. This makes since the purchase of capital is essentially an investment in the future revenues of the company.

Financing Activities

The final financial activity are financing activities. These are activities like repurchasing and issuing shares, issuing/repaying debt, and interest expense. These are activities that do not have to do with the purchase of physical objects, and instead is usually composed of financial securities, particularly debt and shares. Dividend payment is a financial activity and a company’s dividends will appear in this section of the company’s financials.

What Do the Cash Flows Signify?

So what does the different cash flows from the various activities mean to you? First let’s take a look at the cash flows from operating activities. Cash flows from operating activities are a lot like gross profit in that if it isn’t positive it is a major warning sign. A negative cash from operating activities tells the investor that the company is not making money from its primary focus of the business. This tells us there is likely a fundamental flaw with their business plan. Look for an operating cash flow that is large and positive as this shows that the company is profiting from the sale of its good or service.

Next up is the investing cash flow. Contrary to many people’s intuition, you want to have a negative cash flow from investing activities. The reason for this is simple: new capital costs more than old capital. Negative investing cash flow shows that a company is investing in its future, whereas a positive investing cash flow can signify that a company is selling off its assets and may be preparing to liquidate.

Finally there is the financing cash flow. This can be either positive or negative but it is good to take a look and see why it is the way it is. A positive financing cash flow can signify the company freeing up money for investments. Meanwhile, a negative investing cash flow can be caused by a company paying down its debts. This can give you a good indication of what direction the company is going.

Conclusion

In conclusion, looking at how a company spends its money across its different activities gives us lots of information. This can also give us insights into what direction the company is looking to take in the future. Also, cash flows can supply warning signs of a company who is struggling. As such, viewing the cash flows of various activities is important when analyzing a corporation.

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