Learning Objectives

Change in Cash Balance

When interpreting cash flows, quote the figures of the 'cash and cash equivalents' at the start of the period, and at the end of the period. Comment on whether the cash balance has increased or decreased.

Consider whether the business still has a strong cash balance, or has the balance gone into overdraft? (negative cash balance).

Interpretations: Increase in Cash Balance: Favourable, the business is generating more positive cash flow. Decrease in Cash Balance: Unfavourable, the business is generating less cash flow.

Operating Activities

Interpretations:

Positive Cash Flow: Favourable and a healthy indicator for the business as it means the cash inflows from customers is sufficient to cover the payments for operating (payments to suppliers and employees).

Negative Cash Flow: Unfavourable and is a concerning factor for the business as it means the cash inflows from customers are insufficient to cover its operation payments, and the money to cover this shortfall needs to come from other areas.

Other Points to Consider:

A business cannot survive in the medium to long term unless it generated positive net cash flows from operating activities.
If the dividend paid out is larger than the net cash of operating activities, this indicates an excessive dividend payout.

Investing Activities

Interpretations:

The interpretations for this section is dependent on the type of cash transactions being taken place.

Sale of Assets: Unfavourable indicator as the business has sold non-current assets to finance a negative net cash flow from operating activities. The business may be downsizing operations. - Purchase of New Property, Plant and Equipment: Favourable as the business has purchased non-current assets that can be used to generate income in the future.
Income from Investments: Favourable, as investments are generating a favourable return. - Purchase of Shares and Other Investments: Favourable, as the business is investing idle cash to generate a higher return.

Points to Consider:

If the dividend paid out is smaller than the net cash of operating activities, this indicates the business has retained some profits rather than paying dividends. Check whether this money is being efficiently invested in the investing activities section.

Financing Activities

Interpretations

Negative Cash Flow: Unfavourable as the business had to borrow money, or raised additional share capital to pay for negative net cash in operating activities.

Positive Cash Flow: Favourable, as the business has reduced its debt position or delivered a return to shareholders.

Points to Consider:

Consider whether the business has used equity or debt financing to purchase non-current assets. A negative cash flow under the financing section could be a productive use of money is invested to generate a higher return.