According to the U.S. Small Business Administration, developing an effective system for analyzing cash flow is crucial for managing funds and avoiding problems down the line. The act of choosing the right cash flow model for your type of business, however, can be easier said than done.
If you want to evaluate the ways in which cash moves between a company, its owners and investors, you may choose to calculate the cash flow from financing activities.
Why Tracking Cash Flow From Financing Activities Is Important
One of the most common forms of cash flow analysis, cash flow from financing activities (CFF) conveys a business’ fiscal wellness by evaluating how it raises funds and repays investors. Activities that are relevant when calculating CFF include paying cash dividends, adding new loans or altering existing ones, and issuing more shares of stock. If your company regularly takes out new debts in order to cover cash shortages, it may be a sign that you’re headed for dire financial straits down the line.
Investors often use CFF to evaluate whether or not a company is a good investment. This cash flow metric reveals the percentage of funds that comes from financing as opposed to genuine business operations and can offer valuable insight into a company’s ability to pay its debts.
Additionally, CFF can help investors determine if a company is poised for expansion. While negative cash flow from financing activities can suggest a good liquidity position, a positive cash flow may indicate that a company is gathering finances in order to fund growth.
When to Calculate Cash Flow From Financing
Cash flow from financing is a crucial metric when a company is looking to buy back shares of its stock. Most fiscally healthy companies try to repurchase their own stock on an annual basis. After all, as shares are retired, the remaining stock is worth more. If a company lacks the cash flow to repurchase its stock, more financial problems could be imminent.
Generally, cash flow from financing activities is most important for larger businesses that carry some amount of debt from one quarter to the next. If you operate a smaller company that is debt free and doesn’t pay dividends on a regular basis, you may have little reporting information for this section of your financial statement.
Tracking Cash Flow From Financing Activities
Companies can use a simple formula to calculate their cash flow from financing activities. Start by adding up the value of cash received from issuing stocks or debts. Next, calculate cash paid as dividends, or money given to shareholders. Finally, you need to assess the cost of reacquiring any stocks or paying off debts. Cash flow from financing activities is then equal to:
Cash Received From Issuing Stock or Debts – Cash Paid as Dividends and Stock Reacquisition = CFF
It’s important to note that calculating a negative cash flow from financing activities is not necessarily cause for despair. While a negative figure could indicate that a business is taking on too much debt, it could also suggest that the company is making larger payments in order to satisfy debt more quickly. Additionally, cash flow may be negative if a business starts repurchasing its own stock. On the other hand, a healthy business could demonstrate positive cash flow from financing activities if it’s raising money in order to expand.
Clearly, cash flow from financing activities is a valuable metric for a business to track. By gathering the widest range of data, you can make more informed decisions and give your company a greater chance of standing the test of time.
For more help on tracking cash flow, see our article on the six essentials of a cash flow statement.