Analyzing Cash Flow From Financing Activities

The cash flow statement is one of the most important but often overlooked components of a firm’s financial statements. It shows analysts, investors, credit providers, and auditors the sources and uses of a company’s cash.

It’s important to consider each of the various sections that contribute to the overall change in cash position when analyzing a company’s cash flow statement, A firm may have negative cash flow overall for a given quarter but the negative overall cash flow isn’t necessarily a bad thing if the company can generate positive cash flow from its business operations.

Cash Flow From Financing Activities

The financing activity in the cash flow statement focuses on how a firm raises capital and pays it back to investors through capital markets. These activities also include paying cash dividends, adding or changing loans, or issuing and selling more stock. This section of the statement of cash flows measures the flow of cash between a firm and its owners and creditors.

A positive number indicates that cash has come into the company, boosting its asset levels. A negative figure indicates that the company has paid out capital such as by retiring or paying off long-term debt or making a dividend payment to shareholders.

Examples of common cash flow items stemming from a firm’s financing activities include:

Reasons for Financing

Financing activities show investors exactly how a company is funding its business. A business accesses the capital markets through the issuance of debt or equity if it requires additional capital to expand or maintain operations. The decision between debt and equity financing is guided by factors that include cost of capital, existing debt covenants, and financial health ratios.

Large, mature companies with limited growth prospects often decide to maximize shareholder value by returning capital to investors in the form of dividends. Companies hoping to return value to investors can choose a stock buyback program rather than paying dividends.

A business can buy its own shares, increasing future income and cash returns per share. Repurchases are an attractive way to maximize shareholder value if executive management feels that shares are undervalued on the open market.

Financing Examples

Consider Apple’s (AAPL) 2014 10-K filing. The largest line items in the cash flow from the financing section are dividends paid, repurchase of common stock, and proceeds from the issuance of debt. Dividends paid and repurchase of common stock are uses of cash and proceeds from the issuance of debt are a source of cash.

Apple decided that shareholder value would be maximized if cash on hand was returned to shareholders rather than used to retire debt or fund growth initiatives. Apple wasn’t in a high growth phase in 2014 but executive management likely identified the low interest rate environment as an opportunity to acquire financing at a cost of capital below the projected rate of return on those assets.

Kindred Healthcare’s 2014 10-K filing showed that the company engaged in several financing activities after announcing its intention to acquire other businesses. Noteworthy line items in the cash flow from financing section included proceeds from borrowing under a revolving credit facility, the issuance of notes, an equity offering, repayment of borrowings under a revolving credit facility, repayment of a term loan, and dividends paid.

Kindred Healthcare paid a dividend but the equity offering and expansion of debt were larger components of financing activities. Kindred Healthcare’s executive management team had identified growth opportunities requiring additional capital and they positioned the company to take advantage through financing activities. Kindred Healthcare was acquired and became a private company in 2018.

Accounting Standards: IFRS vs. GAAP

U.S.-based companies are required to report under generally accepted accounting principles (GAAP). Firms rely on International Financial Reporting Standards (IFRS) outside the United States. Some of the key distinctions between the two standards boil down to some different categorical choices for cash flow items.

Understanding the Balance Sheet

Analyzing the cash flow statement is extremely valuable because it provides a reconciliation of the beginning and ending cash on the balance sheet. This analysis is difficult for most publicly traded companies because of the thousands of line items that can go into financial statements.

A company’s cash flow from financing activities typically relates to the equity and long-term debt sections of the balance sheet. One of the better places to observe the changes is in the consolidated statement of equity.

A Balance Sheet Example

Here are some numbers from Covanta Holding Corp.

The common stock repurchase of $88 million is broken down into a paid-in capital and accumulated earnings reduction as well as a $1 million decrease in treasury stock. The treasury stock balance declined by $1 million in Covanta’s balance sheet, demonstrating the interplay of all major financial statements.

Changes in long-term debt can be found on the balance sheet as well as notes to the financial statements to summarize other linkages between a firm’s balance sheet and cash flow from financing activities.

Dividends paid can be calculated by taking the beginning balance of retained earnings from the balance sheet, adding net income, and subtracting out the ending value of retained earnings on the balance sheet. This equals dividends paid during the year. This information is found on the cash flow statement under financing activities.

What to Look For

An investor wants to closely analyze how much and how often a company raises capital and the sources of the capital. A company relying heavily on outside investors for large, frequent cash infusions could have an issue if capital markets seize up as they did during the credit crisis in 2008.

It’s also important to determine the maturity schedule for debt raised. Raising equity is generally seen as gaining access to stable, long-term capital. The same can be said for long-term debt which gives a company flexibility to pay debt down or off over a longer period. Short-term debt can be more of a burden because it must be paid back sooner.

The Bottom Line

A company’s cash flow from financing activities refers to the cash inflows and outflows resulting from the issuance of debt, the issuance of equity, dividend payments, and the repurchase of existing stock. It’s important to investors and creditors because it depicts how much of a company’s cash flow is attributable to debt financing or equity financing as well as its track record of paying interest, dividends, and other obligations.

A firm’s cash flow from financing activities relates to how it works with the capital markets and investors who are interested in understanding where a company’s cash is coming from. It’s a sign of a good investment if it’s coming from normal business operations. It might be an unattractive investment opportunity if the company is consistently issuing new stock or taking out debt.

Creditors are interested in understanding a company’s track record of repaying debt as well as understanding how much debt the company has already taken on. A creditor most likely would not loan any money if the company is highly leveraged and hasn’t met monthly interest payments, Creditors should consider lending it money if a company has low debt and a good track record of debt repayment.

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