Warning Signals in Cash Flow Statement

This is by no means an exhaustive list, but any one of the signals could mean there is a problem. The more warning signals there are, the higher the risk.

1. Are receipts from customers lower than payments to suppliers and employees?

There are several things to watch out for if receipts from customers are lower than payments to suppliers and employees on a cash flow statement:

  1. Cash flow problems: If the company is consistently spending more than it is bringing in, it could lead to a lack of cash on hand to pay bills and meet financial obligations.
  2. High accounts payable: If the company is taking longer to pay its suppliers and employees, it can negatively impact relationships with those parties and lead to credit issues in the future.
  3. Poor budgeting and financial management: If the company is consistently having trouble generating revenue or managing its expenses, it may be a sign of poor budgeting and financial management practices.
  4. Financial distress: If the trend continues, it could lead to financial distress and potential bankruptcy.

It is important to monitor these issues and take action if necessary to improve the company’s financial position and cash flow. This may include increasing revenue, reducing expenses, improving financial management practices, or seeking additional funding or financing.

2. Is the net cash flow from operating activities negative or relatively small?

If the net cash flow from operating activities is negative or relatively small in a cash flow statement, it may indicate that the company is struggling to generate enough cash from its normal business operations to cover its expenses. This could lead to cash flow problems, such as difficulty paying bills or meeting financial obligations. There are several things to watch out for:

  1. Negative cash flow: A negative net cash flow from operating activities indicates that the company is burning through cash, and may not be able to sustain its operations in the long-term.
  2. High expenses: If the company has high expenses relative to its revenue, it may be difficult to generate positive cash flow from its operations.
  3. Working capital issues: The company may be having difficulty managing its working capital, such as having difficulty collecting accounts receivable, or having too much inventory on hand.
  4. High levels of debt: The company may be taking on too much debt, which can make it difficult to generate positive cash flow from operations.
  5. Poor budgeting and financial management: If the company is consistently having trouble generating revenue or managing its expenses, it may be a sign of poor budgeting and financial management practices.

It is important to monitor these issues and take action if necessary to improve the company’s financial position and cash flow. This may include increasing revenue, reducing expenses, improving financial management practices, or seeking additional funding or financing.

3. Is positive cash flow largely the result of non-operating items?

In a cash flow statement, positive cash flow from non-operating items can include proceeds from the sale of investments or assets, interest or dividends received, and gains from foreign exchange. While these can be significant sources of cash, it is important to examine the underlying transactions and assess whether they are sustainable in the long-term. Additionally, it is important to compare the non-operating cash flow to the cash flow from operating activities, as this will provide a better understanding of the company’s overall cash generating ability. It’s also important to look out for any unusual or large non-operating items that may indicate one-time events rather than a sustainable source of cash flow.

4. Is the operating cash flow above/ lower than the operating profit after tax (NOPAT)?

In a cash flow statement, operating cash flow is a measure of the cash generated or used by a company’s ongoing operations. It is calculated by taking the net cash provided by operating activities from the statement of cash flows. Operating profit after tax, on the other hand, is a measure of a company’s profitability from its ongoing operations and is calculated by subtracting operating expenses from revenues.

It is important to watch for differences between operating cash flow and operating profit after tax, as it can indicate whether a company is generating cash from its operations or using cash. A positive difference, or when operating cash flow is higher than operating profit after tax, is seen as a good sign, as it indicates the company is generating cash from its operations. A negative difference, or when operating cash flow is lower than operating profit after tax, can indicate that the company is using cash from its operations, which can be a red flag.

It is also important to note that the operating cash flow and operating profit after tax can be affected by non-cash items such as depreciation and amortization, which can cause a difference between the two figures.

5. Has there been a significant acquisition where goodwill [or other intangible assets] represented a large portion of the price?

In a cash flow statement, a significant acquisition where goodwill or other intangible assets represent a large portion of the purchase price can have a significant impact on the company’s financial statements.

It’s important to pay attention to the following items when a company makes a significant acquisition that includes a large amount of goodwill or other intangible assets:

  1. The financing of the acquisition: The acquisition may have been financed through a combination of cash, debt, and equity. The cash paid for the acquisition will reduce the company’s cash balance and affect the operating cash flow.
  2. Impairment testing: Goodwill must be tested for impairment at least annually. If it is found to be impaired, it will be written down, which will have a negative impact on the company’s net income and can affect the operating cash flow indirectly.
  3. Integration costs: There may be costs associated with integrating the acquired company into the existing operations, these costs will affect the operating cash flow.
  4. Impact on revenue and profitability: The acquisition may have a positive or negative impact on the company’s revenue and profitability. It is important to understand how the acquisition will affect the company’s overall financial performance.

It’s important to closely monitor these items to understand the impact of the acquisition on the company’s cash flow and overall financial health. It is also important to note that an acquisition with a high goodwill component may indicate the company has overpaid for the acquisition, which may lead to lower returns in the future.



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