Investment activities here refers to buying and selling of long term assets. As already covered in one of the earlier blogs to determine asset we need to stand at a particular point and look in the future. If the particular item has a future benefit we call it asset. Any asset which provides a benefit of more than one year is know as long term asset.
For the purpose of cash flow from investing activities we need to gauge whether:
1. The asset is being bought or sold.
2. Determine whether cash is involved.
Buying of asset generates a cash outflow or decrease in cash balance and selling of assets lead to cash inflow or increase in cash balance.
It should also be noted that when a company is expanding, it will buy more assets than it sells and this will lead to net cash outflow. In other words for a company which is growing cash flow from investment is negative.
On the other hand, financing activities refers to the process of funding the investments and operation of a business. Following are major sources for long term funding of operations and investing activities:
1. Long Term loans(Debts)(External Sources)
2. Preference Shares (Internal Sources with fixed rate of dividends)
3. Equity Share capital (Internal Sources with dividend rates not fixed).
A. The important fact to be remembered is issue of debts/equity share capital/preference capital leads to cash inflow.
B. On the other hand interests and dividends which are servicing costs associated with these sources of capital lead to cash outflow.
C. Redemption of debentures (Debt) and Equity/Preference leads to outflow of cash.
Here is a format for cash flow statement:
Cash flows from operating activities (CFO)
Profit after taxation
Add:Depreciation
Add:Interest expense
Add:Profit on the sale of property, plant & equipment
Working capital changes:
(Increase) / Decrease in trade and other receivables
(Increase) / (Decrease) in inventories
Increase / (Decrease) in trade payables
Cash Flow from Operating Activities
Cash flows from investing activities (CFI)
Less: Business acquisitions, net of cash acquired (purchases of business leads to cash outflow ; hence negative)
Less:Purchase of property, plant and equipment(PP&E) (purchases of PP&E leads to cash outflow ; hence negative)
Proceeds from sale of equipment (leads to cash inflow ; hence positive)
Less: Acquisition of portfolio investments (leads to cash outflow ; hence negative)
Add: Investment income (leads to cash inflow ; hence positive)
Net cash used in investing activities Cash flows from financing activities (CFF)
Add: Proceeds from issue of share capital (Cash inflow)
Add: Proceeds from long-term borrowings (Cash inflow)
Less: Payment of interest on long term borrowings (Cash Outflow)
Less: Payment of Dividend on preference and Equity share capital (Cash Outflow)
Redemption of shares and debentures (Debts)(Cash Outflow)
Net increase in cash and cash equivalents (CFO+CFI+CFF) Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period (Should match with the cash and cash equivalent in the balance sheet)
Author: Abhishek Sinha
Abhishek Sinha has approximately 8 year of experience in equity research, business research and consultancy. He has also had the privilege of managing a small portfolio of INR 3 million. However, his interest lies in teaching and "demystifying concepts." He has taught students right from the age of 3 years at PP1, to 40 years at executive courses and believes teaching is not about knowing the concepts; it is about relating the concepts to the audience. At present he is "gainfully employed" at Vignana Jyothi Institute of Management, Hyderabad; where he loves to teach finance to an enthusiastic bunch of management students. His hobbies include analyzing income statement, balance sheet and cash flow.> Google +
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