Yahoo Finance Yahoo U: Breaking down cash flow
Throughout this earnings season, cash flow has been the big story for companies like General Electric and Tesla. In GE’s fourth-quarter earnings report, the company reported a full-year industrial cash flow for 2019 of $2.3 billion, above the company’s guidance range, which was between $0 and $2 billion. It was a similar at Tesla, where the company generated $1 billion of free cash flow last year.
While net income can help explain the profitability of a company, cash flow can serve as a useful measure of a company’s health. A strong cash position can tell investors a lot about the company’s ability to pay capital out to its shareholders or its capacity to make strategic investments in the future.
The cash flow statement is one of three major financial statements reported by public companies and sheds light on the inflow and outflow of a company’s cash. (The other two are the income statement and the balance sheet.)
Under U.S. generally accepted accounting principles (GAAP), the cash flow statement is broken up into three sections: operating activities, investing activities, and financing activities.
Operating activities
The operating section broadly covers the profits of a company. Beginning with net income, the operating cash flow statement makes adjustments to measure how much of the money made is in cash available to the company as of its financial filing.
One example of an adjustment would be depreciation. In the income statement, net income would account for “charges” related to any loss of value in machinery or equipment. But declining value of a company’s machinery isn’t a direct cash charge (the company doesn’t pay anyone a certain amount of money because their machines are getting older). Operating cash flow therefore adds back any losses related to depreciation.
Similar methodologies are applied to other financial accounting concepts like amortization and impairment charges. Any accounts receivable, which would cover processing payments or deferred payments, would also be deducted in this section. Even though a company is expecting the cash, not having it at the moment needs to be accounted for.
Investing activities
Any investments made by the company also need to be accounted for in the investing section of the cash flow statement.
Typical examples of investing activities would be capital expenditures like acquisition costs from a merger or the purchase of any property or equipment.
Investing in research and development would also be covered under the investing section of the cash flow statement.
Financing activities
The final section of the cash flow statement accounts for financing activities.
Companies may opt to raise money by issuing equity (i.e. common stock) or corporate debt (i.e. bonds). Both would represent cash inflows in the financing activities section of the cash flow statement.
Companies may also decide to pay out cash to shareholders in the form of dividends or buybacks, which would represent cash outflows in the financing activities section of the cash flow statement.
Free cash flow
Earnings analysis often includes an analysis of “free cash flow,” which is a non-GAAP metric calculated as operating cash flow minus capital expenditures.
Free cash flow broadly measures the amount of cash available to pay out to shareholders.
Brian Cheung is a reporter at Yahoo Finance. Valentina Caval is a producer.
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