Typically, a cash flow statement or statement of cash flows will show you how changes in income and balance sheet account statements affect cash and cash equivalents. It is one of the most critical documents within the list of financial statements for any organization, in addition to the balance sheet and income statement.
You can break down the flow of cash and cash equivalents based on financing, investing and operating activities a company engages in. And one of the things you can calculate by reading a cash flow statement is the net cash provided by financing activities.
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What's Net Cash Provided by Financing Activities?
Within a cash flow statement, financing activities are related to company investors and creditors like banks. So, any transactions associated with debt, dividends or equity will fall under this category, which is listed as a line item on the cash flow statement.
For example, when a company raises capital by selling shares or a corporate bond, it will record the cash raised as incoming cash. And when it pays dividends to its owners or investors or repurchases company stock, those amounts will be recorded as outgoing cash.
So, cash flow from financing activities refers to the cash flow arising from a company’s financing activities within a specified period. However, for non-profits, the line item will include the sum of donations for financing the organization’s long-term goals.
Therefore, net cash flow from financing activities refers to the difference between the incoming cash and outgoing cash flows within the cash flow statement. It can be positive or negative, depending on whether a company maintains cash and cash equivalent reserves or not. And it indicates how well the organization’s capital structure is managed and its overall financial strength.
Why Understanding Cash Flow's Essential
Learning how much money is entering and leaving your business accounts is crucial. Research shows that as many as 82 percent of businesses fail due to cash flow problems or the inability to understand cash flow.
That is because the lack of cash flow affects your business in several ways. Below are some of them:
- Cash and cash equivalents enable you to weather the tough times. So, if a company has no cash, it will have issues paying its debts and may end up having to sell its assets.
- Having a poor cash flow makes it more difficult for businesses to operate or get goods on credit. That’s because suppliers may consider it an indication they won’t get paid.
- If a business has minimal or poor cash reserves, it cannot take advantage of limited investment opportunities that present themselves.
- If a company does not have cash reserves, it cannot engage in short-term planning while looking for additional capital to plan for the long term.
Calculating Net Cash Flow From Financing Activities
Below are the steps you should take as an investor to determine whether a company has a well-managed capital structure.
- Start by finding the statement of cash flows of the company you are interested in. You can search for it within the company’s Form 10-Q quarterly report or Form 10-K annual report. And the list of financial statements is usually available on the U.S. Securities and Exchange Commission’s EDGAR website or the investor relations section of most organization websites.
- Look at the cash flow statement and identify the cash flows from financing activities category. List all the money paid out to creditors and investors in one section and capital raised from the same parties in another section. For example, dividend payments, loan repayments to creditors and company stock repurchases all result in outgoing cash flow. On the other hand, the sale of shares, bond issuance, loans from financial institutions and contributions from donors all result in cash inflow.
- Add all the incoming cash flow activities. For example, if company XYZ issued shares worth $1 million and sold a corporate bond worth a similar amount, its incoming cash is $2 million.
- Add all the outgoing cash flow activities. For example, if company XYZ is paying out dividends worth $50,000, repaid a loan worth $100,000 and repurchased stock worth $100,000, its total outgoing cash flow is $250,000.
- Subtract the sum of outgoing cash flow from the sum of incoming cash flow. Use the formula: CED − (CD + RP) = Net Cash Flow from Financing Activities (CFF), where CED = Cash inflows from issuing equity or debt, CD = Cash paid as dividends and RP = Repurchase of debt and equity. Based on the above example, company XYZ has net cash provided by financing activities worth $2,000,000 - ($50,000 + $100,000 + $100,000), which equals $1,750,000.
Remember that if the cash flow from financing activities is positive, it indicates the company has some cash and cash equivalent reserves. But if the difference is negative, it shows the company lacks cash and may need to borrow money to fund its operations until its cash flow is healthy again.
Read More: How Do I Calculate Cash Dividends?
- If the cash outflows from financing activities were more than the inflows from financing activities, the amount would be negative and would be considered net cash used for financing activities.
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