Cash flow analysis

Cash flow analysis
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Cash flow analysis is one of the methods of determining the financial condition of an enterprise, which involves examining the sources of increasing or decreasing the financial resources in the balance sheet. It presents the measurement of the financial result of the company's activity in a given period. The cash flow statement is the difference between all cash receipts and cash outflows, i.e. net cash flows, which in terms of value is equal to the change in cash balance in the balance sheet (S. C.M. Alamry 2019, pp. 23-27).

Assumption for cash flow analysis

Cash flow analysis statement focuses on cash, which is in the focus of attention of financiers and plays a key, measurable role in economic practice, as opposed to revenues, costs and profits often perceived as "paper", i.e. uncovered in the company. A cash-flow statement makes it possible to assess the origin and volume of cash and cash equivalents, as well as the directions and volume of their use in a given period, makes it useful for users to draw up financial statements concerning them:

  • the company's ability to generate cash receipts and spend them rationally,
  • the period of implementation of the revenue and expenditure and the degree of certainty of its achievement,
  • changes in net assets and the structure of their financing,
  • profit and cash flow relations due to the elimination of the impact of accounting principles and valuation methods, and thus ensures comparability of financial information (A. Baskaya et all., 2018, pp. 81-83).


From the point of view of assessing the financial standing of an enterprise, the cash flow statement shall be used for (M. Reza, R. Kusumaningrum, C Edi. 2017, pp.30-34):

  • to obtain better characteristics of current and future profitability than in the case of the balance sheet and the profit and loss account,
  • the determination of current payment capacity by determining the internal level of self-financing.

Method of the cash flow analysis

When analyzing the income statement, the first step is to assess the cash flows from the various activities (operating, investing and financing) (M. Reza, R. Kusumaningrum, C Edi. 2017, pp.30-34). In making this assessment, account is taken of the specific characteristics of the company and the industry in which it operates. In the course of this preliminary analysis, the examination of the size of individual items is less important. The importance is attached to whether the balance of cash flows from a given activity is negative or positive. There are as many as eight variants of balances from three areas of activity (M. Reza, R. Kusumaningrum, C. Edi, 2017, pp.35-40):

Options Operating activities Investment activities Financial activities
1 + + +
2 + - -
3 + + -
4 + - +
5 - + +
6 - - +
7 - + -
8 - - -
  • Option 1 is characterized by a company with a very high level of liquidity. It is rare in practice. This is usually the case for companies preparing to invest or take over another entity.
  • Policy Option 2 is present in mature, high-yielding companies that finance investment activities and settle liabilities from their surplus.
  • Policy option 3 may be based on two main reasons:
  1. The company generates positive operating and investment income,
  2. The proceeds from the current operations are not sufficient to cover the liabilities, so the company is liquidating its fixed assets and thus raising new funds.
  • Option 4 is typical of developing companies that are unable to cover their development expenses with their profits and therefore obtain external financing. This option is considered to be the most desirable one, demonstrating good prospects for the company.
  • Option 5 concerns companies in temporary difficulties and not generating positive operating cash flows. These units use external sources of finance to maintain liquidity. The fact that they can obtain them is a good symptom indicating that an improvement in the company's result is expected.
  • Policy Option 6, where operating and investment flows are negative and the source of cash to cover shortfalls is credit and equity, is characteristic of young, high-growth companies with good prospects in which creditors are not afraid to invest.
  • Option 7 is for companies in financial difficulties. They maintain liquidity through the sale of fixed assets (M. Reza, R. Kusumaningrum, C. Edi, 2017, pp.35-40).
  • Option 8 may happen in entities that have accumulated large financial resources in previous periods, from which they are currently implementing their investment expenditure. However, this is a risky situation that could result in the bankruptcy of the company (M. Reza, R. Kusumaningrum, C. Edi, 2017, pp.35-40).

When analyzing the cash flow statement, the possible differences between operating cash flow and net profit in the profit and loss account should be explained. The most common cause of these differences is the change in the balance of current assets. The differences are explained by the analysis of the impact of changes in particular items of these assets on the balance of operating cash flows (D. Šteinberga, I. Millere 2016, pp. 25-30).

The advantage of the cash flow analysis

The advantage of the cash flow statement is that it is much less susceptible to manipulation than the financial result (C. Öztürk 2015, pp.11-13). It is also considered that cash flow is a much better indicator of financial potential than a balance sheet. However, in order for the cash flow analysis to be complete, it has to be considered against the conclusions drawn from the indicative analysis of the balance sheet and the profit and loss account (C. Öztürk 2015, pp.11-13).


Author: Barbara Lech