Businesses must maintain adequate funding to survive and grow. Financing activities, or the flow of cash to and from lenders and owners, provides insight into a company's financial health and capital management.
Businesses track the changes in their cash over a given period using a cash flow statement. A cash flow statement includes three sections: operating activities, investing activities, and financing activities.
The financing activities' cash flow section shows how a business raised funds and returned the money to lenders and owners. This section only includes financing activities.
Explaining financing activities
Financing activities are transactions between a business and its lenders and owners to acquire or return resources. In other words, financing activities fund the company, repay lenders, and provide owners with a return on investment.
Financing activities include:
- Issuing and repurchasing equity
- Borrowing and repaying short-term and long-term debt. This activity includes principal payments to lenders and vendors for most capital purchases, as well as the cost to issue debt. Interest payments are operating activities, not finance activities. Transactions with vendors for all other purchases, including operating leases, are also operating activities
- Paying dividends
- Other contributions from, or distributions to, owners
Cash flow from financing activities only tracks financing activities involving cash. An owner contributing a piece of land is one example of non-cash financing activity.
What cash flow from financing activities reveals about a business
Context is crucial when analyzing cash flow from financing activities. Savvy owners and managers ensure that cash flow from financing activities matches their business' unique needs.
A positive cash flow from financing activities shows that a business raised more cash than it returned to lenders and owners. This activity may or may not indicate effective capital management, depending on the specific business circumstances. Individual line items require similar consideration.
Significant debt or equity raises may be a healthy sign for a promising startup or a company planning a significant expansion. Those same transactions might cause concern for a mature company with few growth prospects.
Conversely, many circumstances may cause a large negative cash flow from financing activities. Struggling businesses forced to repay loans due to covenants, partnerships executing a planned wind-up, and maturing companies able to repay debt may all have similar cash flow from financing activities.
The line items in cash flow from financing activities also reveal changes in the capital structure of a business. Every business needs a particular mix of debt and equity. Analyzing cash flow from financing activities can show whether a company is on track to achieve its ideal capital structure.
How to calculate cash flow from financing activities
Calculate cash flow from financing activities for a given period using a simple formula.
Take the cash received from issuing equity and debt, subtract cash paid to repurchase equity and debt, and then subtract funds paid as dividends to calculate cash flow from financing activities.
Below is an excerpt of an example cash flow statement showing only the cash flow from the financing activities section.
ABC Company Cash Flow From Financing Activities:
- Common stock issued $200,000
- Notes payable issued $54,000
- Notes payable repaid ($149,000)
- Dividends paid ($50,000)
- Net cash from financing $55,000
Company ABC received $254,000 from its equity and debt issues. Subtract both the $149,000 of debt repaid and $50,000 of dividends paid to arrive at a (positive) cash flow from financing activities of $55,000.
Through financing activities, Company ABC increased its equity, decreased its debt, and paid just under half of the difference to ownership. The business retained the remainder for its use. These facts will reveal whether Company ABC managed its capital effectively when combined with the goals and circumstances of the business.
Understanding what financing activities are and how they are used to calculate cash flow from financing activities gives decision-makers insight into their businesses' financial health and optimal capital structure.
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