What Does Cash Flow from Financing Activities Mean?

By Ram - Jan 19 2024

There’s a section on cash flow from financing activities somewhere in your cash flow statement. It highlights the cash flow in and out of the company due to financing activities.

Many businesses, especially new and struggling ones, will often seek funding or financing. The financier will use your cash flow statement and cash flow from financing activities to determine your business’s financial health and whether you can honour the repayment of the financing facility.

Although little understood, the cash flow financing statement significantly impacts your business’s financial health and your ability to get funding.

What is a Cash Flow Statement?

To understand cash flow from financing activities, you need to start with the basics, which is the cash flow statement. It is one of the three vital financial reports a company generates regularly. The other two are the income statement and the balance sheet.

The cash flow statement is more regularly generated by companies using the accrual accounting method, where income and expenses are reported immediately after the invoices are raised or bills are received. This helps to keep track of the cash movement within a specific period. This can be monthly or quarterly, depending on the business’s preferences.

Types of Cash Flow

There are different types of cash flow. The essence of the cash flow statement is to group these different types of cash going in and out of the business into three categories;

Cash flow from operating activities

This is cash generated from the everyday running of the primary business operations. It includes transactions pertaining to expenses resulting from operations and net income.

Cash flow from investing activities

This is another category of cash flow based on the income and expenses from the company’s investments into capital assets. Income such as the sale of equipment, machinery and property fall into this type of cash flow from investing activities.

Cash flow from financing activities

This is cash flow generated from debt and equity financing. Dividends to shareholders and loan repayments also fall under this category.

Why not also read: Why Cashflow is Important

These categories of cash flow cover all the money coming in and out of the business over a specified period. These categories help you and potential investors understand your business and how money moves around the company.

What is a Financing Activity?

Financing activities are transactions that involve the flow of cash between a company and its source of finance. Therefore, cash flow financing activities can include;

  • Borrowing and repaying short-term loans
  • Issuing and reacquiring shares from preferred and common stock
  • Paying cash dividends to shareholders
  • Borrowing and repaying long-term loans and liabilities

Money borrowed for short or long-term periods and cash for bonds or shares fall under the category of positive amounts in the cash flow from financing activities. This shows that the company has received money, increasing its cash balance.

If the company pays the loans, pays dividends or purchases shares, this goes in the negative transaction record to indicate that money has left the company and reduced the company’s cash balance.

How to Calculate Cash Flow from Financing Activities

You can calculate the total net cash flow from financing activities on the cash flow statement using the following formula;

CED – (CD+RP) = Net Cash Flow from Financing Activities

Where;

  • CED – is the cash inflows from issuing debt or equity
  • CD – Is the cash paid as dividends
  • RP – is the repurchase of equity and debt.

From this formula, you can calculate cash flow from financing activities in five simple steps;

  • Add the cash inflows generated from issuing equity and debt (CED) together
  • Add total cash paid as dividends (CD) together
  • Add cash outflows incurred by repayment or debt and equity repurchase (RP) together.
  • Add cash outflows together (CD+RP)
  • Subtract the cash outflows (CD+RP) from the cash inflows (CED) to calculate the net cash flow from financing activities.

How to Determine a Healthy Cash Flow From Financing Activities

One of the reasons businesses should determine their cash flow from financing activities is to help them determine if they have a good amount. No set amount determines if a company’s cash flow from financing activities is healthy.

However, potential lenders and investors want to compare operating and financing activities to determine how they are fairing.

A low or negative cash flow from financing indicates that your business is paying off its debts. But if you have a low figure for operating activities, it suggests that you might struggle to continue servicing your debts.

If the bulk of your cash inflow is from debt, it indicates that your business is struggling to generate enough revenue.

Cash flow from operating activities should be the primary source of cash inflow. Financing activities should only be used to supplement growth or cover large, one-off business expenses.

Invoice Financing and Cash Flow from Financing

Many businesses rely on invoice financing to maintain a positive cash flow. Because this involves working with a factoring company, the management might wonder whether these finances fall under cash flow from financing activities.

Why not also read: Invoice Factoring Vs Discounting

Invoice financing is a form of accounts receivable financing. It allows businesses to convert their unpaid invoices into a source of immediate funding instead of waiting for the full payment period of the invoice.

Because the capital is not sourced by the sale of equity or through lending, the cash inflows from invoice financing are considered an off-balance sheet form of funding and categorised as cash flow from operations. That means the business can improve its leverage and get additional funding without breaching the terms of its existing financial obligations.

If your business is among those that often struggle with long waiting periods for customers to pay their invoices, you should consider invoice financing. It’s a quick, painless way that helps your business maintain a positive cash flow and doesn’t damage your cash flow statement.

For more information on invoice financing and how you can get approved for this option, you can get in touch with Key Factors, the leading invoice financing and factoring service in Australia.

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