Cash Flows

Interpreting Cash Flows

An overall positive increase in cash held is desired, but the sources of the positive cash flow is what is most important.

Operating Activities

Cash Surplus on Operating Activities

This is a positive indicator of the business as it means the business's operations are generating a positive cash flow, an indicator of good cash management. 

Cash Deficit on Operating Activities

This is concerning as it means the business's operations are reducing cash from the business. The business could be making a profit on paper, but in reality, has poor cash management and turning over insufficient cash to meet debt obligations, an indicator of insolvency.

 

Investing Activities

Cash Surplus on Investing Activities

This could be interpreted as a negative indicator as it means the business is selling more non-current assets then it is investing in non-current assets. This suggests the business is reducing it's future ability to generate economic benefits. A business has only a finite amount of non-current assets, and selling assets is not a reliable way of financing debt repayments or cash deficits on operating activities. 

Cash Deficit on Investment Activities

This could be interpreted as a positive indicator as it means the business is investing in non-current assets and increasing it's ability to produce a larger economic benefits in the future. However, you must consider how this is being financed. If the investment in non-current assets is being funded from positive operating cash flows, this is acceptable, but if it was being financed from additional borrowings or share issues, this could be concerning. 

Financing Activities

Cash Surplus on Financing Activities

This could be interpreted as a negative indicator as it means the business is issuing more shares or increasings its borrowings to finance its cash deficits in operating or investing activities. If the cash surplus is used to finance deficits on investing activities, this could be acceptable as the investment could generate economic benefits greater than finance costs.

 

However, this is concerning if it is used to finance a deficit on operating activities, because it means the business is borrowing or issuing more shares to finance it's day to day operations, which could lead to a debt trap. 

Cash Deficit on Financing Activities

This could be interpreted as a positive indicator as it means the business is reducing its external obligations. Repayment of borrowings means the business is reducing debt obligations, reducing finance costs and liabilities.

Share buy backs, means the business is reducing the amount of ordinary shareholders, which could result in more larger level of retained earnings being re-invested in the business as it would usually result in a lower total dividend payout. 

(Note: Share buy backs would not appear in any WACE question)

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