Managing Cash Flow

Interpretation and Analysis of Cash Flow 313
CASH SHOULD COME FROM OPERATIONS
AND SHOULD BE USED FOR INVESTING,
WITH FINANCING AS THE BALANCING NUMBER.
Cash Flows from (for) Investing Activities
Investing activities are the next part of the Statement of Cash Flows that needs to
be examined. These, in most cases, will represent the major uses of the cash flow
of the business. Outlays for property, plant and equipment or new business
acquisitions represent the company’s investment in its own future, and most of
the company’s cash outflow over time should be in this area. A rule of thumb for
the company to consider is that it should reinvest at least the amount of its real,
straight-line depreciation in new property, plant and equipment so as to preserve
its investment base. Because of inflationary pressures over time, reinvestment by
only the amount of depreciation is unlikely to be sufficient, but it can be considered
a minimum. Even higher levels of investment may be necessary for certain
types of business and generally will be an indication of growth and improvement,
but this also needs to be examined carefully. Reinvestment for the sake of
reinvestment is wasted cash. The amount of reinvestment should be logical,
planned, and appropriate for the circumstances of the company. Too much reinvestment
uses up cash indiscriminately—an unwise action on the part of the
company managers.
Cash Flows from (for) Financing Activities
Cash from or for financing activities can be considered as a balancing number,
and as such is generally subordinate in operating significance to the other two
classifications. This is not to say that the financing section can or should be overlooked.
It needs to be reviewed carefully to determine how the company is handling
its debt obligations and related financing transactions. Too much borrowing
over too long a period of time will eventually cause trouble for the company. Too
little borrowing may be an indication of overly cautious management and eliminates
the possibility of gaining the benefits of leverage. Changes in the capital
structure of the company will, from time to time, have to be made and can significantly
affect the overall financial position and cash flow of the company. But these
kinds of major changes tend to be relatively infrequent and do not have the more
immediate impact of cash flow generated by operating and investing activities.
From an interpretation standpoint, it should be obvious that over time the
company’s main cash flow should be generated by operations and used for investing
activities, with financing cash flows as a fluctuating balancing number
between the other two. This should be the basis for initially determining the
appropriateness of company cash flow. The logical follow-up questions are “How
much from operations?” and “How much for investing?” Unfortunately, there are