The cash flow statement is one of the most important but often overlooked, of a firm’s financial statements. In its entirety, it lets an individual, whether he or she is an analyst, investor, credit provider or auditor, learn the sources and uses of a company's cash. Without proper cash management, and regardless of how fast a firm’s sales or reported profits on the income statement are growing, a firm cannot survive without carefully ensuring that it takes in more cash than it sends out the door.
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 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.
Below, we will cover cash flow from financing activities, one of three primary categories of cash flow statements. (The other two sections are cash flow from operations and cash flow from investing activities. The cash flow from the financing section of the cash flow statement usually follows the operating activities and the investing activities sections.)
Negative overall cash flow is not always a bad thing.
What Is Cash Flow From Financing Activities?
The financing activity in the cash flow statement focuses on how a firm raises capital and pays it back to investors through the capital markets. These activities also include paying cash dividends, adding or changing loans, or issuing and selling more stock. This section of the statement of cash flows measures the flow of cash between a firm and its owners and creditors.
A positive number indicates that cash has come into the company, which boosts its asset levels. A negative figure indicates when the company has paid out capital, such as retiring or paying off long-term debt or making a dividend payment to shareholders.
Examples of more common cash flow items stemming from a firm’s financing activities are:
- Cash flow from financing is one if three categories of cash flow statements.
- If a company's business operations can generate positive cash flow, negative cash flow isn't necessarily bad.
- The largest line items in this statement are dividends paid, repurchase of common stock, and proceeds from issuance of debt.
Examining a Statement
To more clearly illustrate, here is an actual statement of cash flow that covers three years of finance activities for waste-to-energy company Covanta Holdings (CVA), which is very active in the capital markets and in raising capital:
In its 2012 10-K filing with the Securities Exchange Commission (SEC), Covanta provides a summary of its liquidity and capital resources activities. It details that it repurchased 5.3 million of its own shares at an average cost of $16.55 per share, which adds to the $88 million in the above financing cash flow schedule. It also paid out $90 million in dividends to shareholders, which included the early payout of first quarter 2013 dividends to help shareholders due to the fact that the taxes on dividends increased in 2013.
As you can see above, it raised more than $1 billion in long-term debt, stemming from a mix of a senior credit facility that is due in 2017 and a term loan due in 2019. It used some of these proceeds to pay off a past term loan. It summarized that net cash used during 2012 was $115 million that “was primarily driven by lower common stock repurchases, partially offset by higher cash dividends paid to stockholders and the 2012 corporate debt refinancing and project debt refinancing.”
Financing activities show investors exactly how a company is funding its business. If a business requires additional capital to expand or maintain operations, it accesses the capital market through the issuance of debt or equity. The decision between debt and equity financing is guided by factors including cost of capital, existing debt covenants and financial health ratios.
Large, mature companies with limited growth prospects often decide to maximize shareholder value by return capital to investors in the form of dividends. Companies hoping to return value to investors can choose a stock buyback program rather than paying dividends. A business can buy its own shares, increasing the future income and cash returns per share. If executive management feels shares are undervalued on the open market, repurchases are an attractive way to maximize shareholder value.
Consider Apple's (AAPL) 2014 10-K filing. The largest line items in the cash flow from financing section are dividends paid, repurchase of common stock and proceeds from issuance of debt. Dividends paid and repurchase of common stock are uses of cash, and proceeds from the issuance of debt are a source of cash. As a mature company, Apple decided that shareholder value was maximized if cash on hand was returned to shareholders rather than used to retire debt or fund growth initiatives. Though Apple was not in a high growth phase in 2014, executive management likely identified the low interest rate environment as an opportunity to acquire financing at a cost of capital below the projected rate of return on those assets.
Consider Kindred Healthcare's (KND) 2014 10-K filing. The company engaged in a number of financing activities during 2014 after announcing intentions to acquire other businesses. Noteworthy line items in the cash flow from financing section include proceeds from borrowing under revolving credit, proceeds from issuance of notes, proceeds from equity offering, repayment of borrowings under revolving credit, repayment of term loan, and dividends paid.
While Kindred Healthcare pays a dividend, the equity offering and expansion of debt are larger components of financing activities. Kindred Healthcare's executive management team has identified growth opportunities requiring additional capital and positioned the company to take advantage through financing activities.
IFRS Versus GAAP
U.S.-based companies are required to report under generally accepted accounting principles or GAAP. International financial reporting standards (IFRS) are relied on by firms outside of the U.S. Below are some of the key distinctions between the two standards, which boils down to some different categorical choices for cash flow items. These are simply category differences that investors need to be made aware of when analyzing and comparing cash flow statements of a U.S.-based firm with an overseas company.
Breaking Down the Balance Sheet
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, but the theory is important to understand. A company’s cash flow from financing activities typically relates to the equity and long-term debt sections of the balance sheet. One of the better places to observe the changes in the financing section from cash flow is in the consolidated statement of equity. Here are Covanta's numbers:
The common stock repurchase of $88 million, which is also on the cash flow statement we saw earlier, is broken down into a paid-in capital and accumulated earnings reduction, as well as a $1 million decrease in treasury stock. In Covanta’s balance sheet, the treasury stock balance declined by $1 million, demonstrating the interplay of all major financial statements.
To summarize other linkages between a firm's balance sheet and cash flow from financing activities, changes in long-term debt can be found on the balance sheet, as well as notes to the financial statements. Dividends paid can be calculated from taking the beginning balance of retained earnings from the balance sheet, adding net income, and subtracting out the ending value of retained earnings on the balance sheet. This equals dividends paid during the year, which is found on the cash flow statement under financing activities.
What to Look For
An investor wants to closely analyze how much and how often a company raises capital and the sources of the capital. For instance, a company relying heavily on outside investors for large, frequent cash infusions could have an issue if capital markets seize up, as they did during the credit crisis in 2007. It is also important to determine the maturity schedule for debt raised. Raising equity is generally seen as gaining access to stable, long-term capital. The same can be said for long-term debt, which gives a company flexibility to pay debt down (or off) over a longer time period. Short-term debt can be more of a burden as it must be paid back sooner.
Returning again to Covanta, the firm must have access to stable, long-term capital because the waste-to-energy facilities it builds cost millions of dollars and are under contracts with local governments and municipalities that can last for a decade or more. The energy that is provided (in most cases, steam is generated from the burning of trash and related waste) is also sold under long-term energy contracts. As such, the financing portion of its cash flow statements is very pertinent to how it builds plants and raises the funds to do so over many years.
The Bottom Line
A company's CFF activities refer to the cash inflows and outflows resulting from the issuance of debt, the issuance of equity, dividend payments and the repurchase of existing stock. It's important to investors and creditors because it depicts how much of a company's cash flow is attributable to debt financing or equity financing, as well as its track record for paying interest, dividends and other obligations. A firm’s cash flow from financing activities relates to how it works with the capital markets and investors.
Through this section of a cash flow statement, one can learn how often (and in what amounts) a company raises capital from debt and equity sources, as well as how it pays off these items over time. Investors are interested in understanding where a company's cash is coming from. If it's coming from normal business operations, that's a sign of a good investment. If the company is consistently issuing new stock or taking out debt, it might be an unattractive investment opportunity.
Creditors are interested in understanding a company's track record for repaying debt, as well as understanding how much debt the company has already taken out. If the company is highly leveraged and has not met monthly interest payments, a creditor should not loan any money. Alternatively, if a company has low debt and a good track record of debt repayment, creditors should consider lending money.