What it means
The cash flow statement divides all cash movements into three activities. Operating activities generate cash from the business itself; investing activities spend it on, or recover it from, long-term assets; financing activities deal with the capital providers, lenders and shareholders, who fund the difference.
If operations produce $10 million and investment absorbs $15 million, financing must supply $5 million or cash falls; if operations produce $10 million and investment takes $4 million, the surplus of $6 million is either returned through financing or added to cash. The section's typical lines are: proceeds from issuing shares (net of issue costs); payments to repurchase shares; proceeds from new borrowings (loans drawn, bonds issued); repayments of borrowings; repayment of the principal portion of lease liabilities (under IFRS 16 and ASC 842, since the lease is a financing); dividends paid to shareholders (IFRS allows a choice between operating and financing; US GAAP requires financing); dividends paid to non-controlling interests; and, under IFRS where the company so elects, interest paid.
Transactions with no cash movement, such as a bonus share issue, a conversion of debt to equity, or an asset acquired under a new lease, are excluded from the statement and disclosed separately. Reading the section in context gives the pattern.
A young company shows share issues and borrowings funding negative operating cash flow and heavy investment. A company in expansion shows borrowing to fund investment beyond operating cash flow.
A mature company shows repayments, dividends and buybacks absorbing the operating surplus. A company in trouble may show emergency borrowing while investing activities show asset sales, or, at the end, repayments forced by lenders while operations cannot fund them.
Several of these patterns look alike in a single year; the trend across years, and the relationship with the other two sections, distinguishes them. The section also reveals policy.
The balance between borrowing and share issues shows how the company chooses to fund growth and how its leverage is moving. The balance between dividends and buybacks shows how it returns capital.
A company whose dividends and buybacks consistently exceed its free cash flow is borrowing to pay shareholders, which the financing section makes visible in a way the income statement does not. Analysts use the financing section to compute free cash flow to equity (what remains for shareholders after debt flows), to check that reported debt movements reconcile to the balance sheet (the "net debt reconciliation" now required under IFRS), and to assess the sustainability of distributions.
Lenders use it to see whether the company is repaying debt from operations or from new borrowing.
In practice
Real-world examples.
Example
A start-up's financing section shows $20 million of preference share proceeds and nothing else, funding a $12 million operating outflow and $5 million of investment.
Example
A utility shows $300 million of bond issuance and $250 million of bond repayments, refinancing its debt, plus $150 million of dividends funded from operations.
Example
A company in difficulty shows $40 million of emergency borrowing in financing and $35 million of asset disposals in investing, with operations producing nothing.
Think of it
“Cash from financing shows money raised from or paid back to the people funding your business.
Formula
Calculation
Cash Flow from Financing Activities = Proceeds from share issues + Proceeds from borrowings minus Repayments of borrowings minus Lease principal paid minus Share buybacks minus Dividends paid (minus Interest paid, where classified here)
Change in Cash = Operating cash flow + Investing cash flow + Financing cash flow
Worked example. A retail group's cash flow for the year:
- Operating activities: net inflow $24,000,000
- Investing activities: new stores and refits $18,000,000; acquisition of a small chain $9,000,000; sale of a warehouse $3,000,000; net outflow $24,000,000
- Financing activities: new term loan drawn $12,000,000; repayment of revolving facility $4,000,000; lease principal paid $7,500,000; dividends paid $5,000,000; share buyback $2,000,000; proceeds of shares issued under employee schemes $500,000
Financing cash flow = $12,000,000 + $500,000 minus $4,000,000 minus $7,500,000 minus $5,000,000 minus $2,000,000 = minus $6,000,000
Change in cash = $24,000,000 minus $24,000,000 minus $6,000,000 = minus $6,000,000. Opening cash $14,000,000; closing $8,000,000.
Reading: operations funded investment exactly, so the $7,000,000 of dividends and buybacks and the $7,500,000 of lease principal were paid partly from new borrowing ($8,000,000 net) and partly from cash ($6,000,000). Free cash flow (operating less capex, excluding the acquisition) = $24,000,000 minus $18,000,000 = $6,000,000, of which $7,500,000 went on lease principal (an obligation as fixed as loan repayments): free cash flow after leases was minus $1,500,000. The distributions of $7,000,000 were therefore entirely funded by the new loan. The board's dividend was "covered 2.5 times by earnings"; on a cash basis it was not covered at all.
Net debt reconciliation: opening borrowings $30,000,000 + new loan $12,000,000 minus repayment $4,000,000 = $38,000,000; opening leases $35,000,000 + new leases (non-cash) $9,000,000 minus principal paid $7,500,000 = $36,500,000; cash $8,000,000. Net debt including leases: opening $51,000,000, closing $66,500,000, an increase of $15,500,000 in a year the company described as one of "disciplined growth".Case study
Seen in the real world.
A listed engineering company presented a slide each year showing "cash returned to shareholders" rising steadily: dividends and buybacks had grown from $30 million to $75 million over five years. An analyst laid the financing section alongside the other two. Operating cash flow over the five years totalled $310 million; investment $260 million; free cash flow $50 million.
Shareholders had received $260 million. The difference, $210 million, had come from the financing section's other lines: net new borrowing of $180 million and a $30 million reduction in cash. Net debt had risen from $120 million to $300 million, and the company's leverage had moved from 1.2 to 2.9 times EBITDA.
The analyst's note was titled "Returning borrowed money", and its point was that the financing section had shown the whole story every year: the cash given to shareholders had come in through the same section from lenders. The share price fell 12% on the note, the company suspended its buyback, and its next annual report replaced the "cash returned" slide with a five-year table of operating, investing and financing cash flows and net debt.
Watch out
Common mistakes.
- Reading the financing section alone. Its meaning depends entirely on what operations generated and investment consumed.
- Forgetting lease principal payments, which are financing outflows as fixed as loan repayments and can be large for retailers, airlines and logistics companies.
- Judging dividend sustainability by earnings cover when the financing section shows distributions funded by borrowing.
Questions
People also ask.
Is interest paid a financing cash flow?
Under US GAAP it is operating. Under IFRS the company may classify it as operating or financing, and must do so consistently and disclose the choice.
Why does a share issue for an acquisition not appear in financing?
Because no cash moved. Non-cash financing transactions (shares issued as consideration, debt converted to equity, assets acquired under lease) are excluded from the statement and disclosed in a note.
What does a large net financing inflow mean?
That the company raised more capital than it returned. Whether that is healthy depends on what the money funded: investment with good returns, or a shortfall in operations.
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