What is Cash Flow from Financing Activities?
When companies require large funding, they do so by issuing equity or raising debt. This is recorded in the cash flow statement. The portion of the net cash generated by a company over a certain time period that goes into funding the firm itself is called Cash Flow from Financing Activities (CFF). Borrowing and repayment of the debt, disbursement of dividends and equity repayments are all a part of Cash Flow from Financing Activities.
Cash Flow as a Part of the Financial Statement
The cash flow statement is one of the three critical financial documents published by a company, which gives a detailed account of how the company is faring in terms of financial performance. They are:
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- Balance Sheet, which provides a snapshot of the total assets and liabilities at the end of the financial year.
- The Profit and Loss Statement, which records all incomes and expenses over a certain time period.
- Cash Flow Statement, which lists all the sources and uses of cash in the given time period.
There are 3 sections in a Cash Flow Statement:
1. Cash Flow from Operations (CFO): This section records all cash flows generated by the core business operations. Cash flows that directly deal with operating activities are accounts payable, accounts receivable, depreciation and amortisation, etc
2. Cash Flow from Investing Activities (CFI): As the name suggests, all cash flows generated or consumed in the buying and selling of capital assets are found in this section. Profits and losses arising from investments in fixed assets are found here.
3. Cash Flow from Financing Activities (CFF): This section essentially captures the flow of cash between the business and its investors, owners, and creditors. As mentioned earlier, here you can find the net funds that are used to finance the company.
Investors who wish to dive into further details about the company’s debt and equity structure can take a look at the ‘liabilities’ and ‘shareholders’ equity’ sections of the company’s balance sheet.
What is included in Cash Flow from Financing Activities?
Cash Flow from Financing Activities umbrellas all cash flows that fund the core operations of a business. That is why all changes in the debt and equity accounts are found here. It is, thus, very important for investors and analysts alike to know what falls under this section of the Cash Flow Statement.
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Cash Flow occurring through the following activities is clubbed under Cash Flow from Financing Activities:
- Issuance/Repayment of equity
- Dividend Payments
- Issuance/Repayment of debt
- Payment of capital/finance lease
Formula and Calculation of CFF
Here is how cash flows from these activities will be treated in the CFF section:
- Cash Inflow: Issuance of debt/equity
- Cash Outflow: Repayment of long-term debt, equity & capital/finance lease obligations
Now that we know what is cash flow from financing activities, let us check the cash flow from financing activities formula.
Where:
CED = Cash inflow from issuance of debt/equity
CD = Cash disbursed as dividends
RP = Repurchase of debt/equity
Example of Cash Flow from Financing Activities
Given below is a snapshot of the CFF of a listed company on the BSE.
As you can see in the Cash Flow from Financing Activities section, the issuance a long-term of debt has been recorded as a positive cash flow (inflow). On the other hand, the payment of dividends, repayments of bank borrowings, interest and lease payments have all been recorded as negative cash flows (outflow).
Since the summation of all these recorded values is negative, it means that there was net cash outflow in the given period, and its major contributor was the repayment of bank borrowings.
Investor warnings from CFF
Whenever a company shows tendencies to borrow, it may reflect positively in the Cash Flow from Financing, but it also means that it is not generating adequate cash flow to sustain its operations. Similarly, a hike in interest rate also raises the repayment amount. Hence investors must be vigilant about such things and have a keen eye for numbers and discrepancies.
On the flip side, if a company is buying back shares from the open market and then issuing dividends while showing unsatisfactory performance, then it is a likely red flag. This move can be a management strategy to bolster its share price and look more valuable although it is not. These actions are not favourable for the company in the long term.
Major deviations from the normal cash flow trend should catch the attention of investors, who must then investigate further by diving deeper. While analysing a Cash Flow Statement, equal attention must be given to all three sections and not just one section alone.
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