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Firstly, we should analyse the structure of cash flow statement.
As known, cash flow statement is divided into three parts: operating cash flow, investing cash flow and financing cash flow. And in operating cash flow, there’re two methods to prepare it: the direct and indirect method of cash flow.
Secondly, when you’re analysing the cash flow, you should note the cash requirements as the following:
- Repayment of existing loans.
All loans to be repaid in the next couple of years should be considered, including any convertible loans. - Increase in working capital.
When the business is expanding, working captial will also need to increase. You should know the coefficient: (Inventory + receivables – payables)/Sales *100%
Suppose this is 30% ans sales are currently $1m, a 20% increase in sales requires finance of 0.06m(1m*20%*30%) to increase the working capital. - Capital expenditure requirements.
It’s necessary to consider whether the company will have sufficient cash to meet this capital expenditure. - Other commitments.
You should know the deadline. - Contingent liabilities.
If these liabilities are very high, their crystallisation could cause real problems for the company. Especially in list companies, guaranting mutually is very dangerous. - Leasing commitments.
If these are material,they should be carefully monitored in relation to the cash available.
So you can know the cash situation of the company when you’re analysing the cash flow. You should note the cash shortfall, after all, that many companies go bankrupt is just because of cash break. Here, if you want to know more details, read Free Cash Flow: Seeing Through the Accounting Fog Machine to Find Great Stocks (Wiley Finance)
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