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 as it moves both in and out. When analyzing a company's cash flow statement, it is important to consider each of the various sections that contribute to the overall change in cash position.
In many cases, a firm may have a negative overall cash flow for a given quarter, but if the company can generate positive cash flow from its business operations, the negative overall cash flow is not necessarily a bad thing.
Cash Flow from Investing Activities
An item on the cash flow statement belongs in the investing activities section if it results from 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, or CAPEX.
Below is a more comprehensive list of cash flows that can stem from a firm’s investing activities:
Firms with excess capital or financial institutions such as banks and insurance companies will have buying and selling activity from their investment portfolios that flow through the investing activity portion of the cash flow statement.
Reading a Company's Cash Flow Statement
A simple cash flow (of investing activities) for restaurant chain Texas Roadhouse (TXRH):
Immediately, you can observe that the main investing activities for Texas Roadhouse are CAPEX. Texas Roadhouse is growing briskly and spends plenty on CAPEX to open new restaurant locations across the United States. In its 10-K filing with the SEC, it details that it spends money to remodel existing stores and build new ones, as well as to acquire the land they are built on. Overall, CAPEX is an extremely important cash flow item that investors are not going to find in reported company profits.
Texas Roadhouse also strategically buys out franchises and spent $4.3 million during 2012 to do 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 Sometimes it may sell restaurant equipment that is outdated or unused, which then brings in cash instead of being an outflow like other CAPEX.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.
Analyzing the cash flow statement is extremely valuable because it provides a reconciliation of the beginning and ending cash on the balance sheet. This analysis is difficult for most publicly-traded companies because of the thousands of line items that can go into financial statements. For Texas Roadhouse, its net property and equipment 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. With regard to 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 pretty clear understanding of the major items on the investing portion of the cash flow statement and what it means for a firm’s financial health.
Significance of Cash Flow Statements
A firm can get itself into trouble by spending foolishly on acquisitions or CAPEX to either maintain or grow its operations. A great 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 it is a growth firm. Yet there is little worry about its financial health because it has 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).
The Bottom Line
Clearly, 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 an individual can do to see how efficiently a company's management is using shareholder capital to run its operations.