Cash From Investments: Where Does The Money Go?

Cash flow from investing activities (CFI) is a crucial aspect of a company's financial health, providing insights into its investment performance and capital allocation decisions. It is one of the three sections of a company's cash flow statement, detailing the cash inflows and outflows from various investment activities. These activities include purchasing and selling investments, earnings from investments, and acquisitions of long-term assets such as property, plant, and equipment. While negative cash flow from investing activities can be concerning, it is not always negative, as it may indicate investments in the long-term health and growth of the company. Understanding CFI helps stakeholders assess a company's ability to invest in growth opportunities and manage its financial well-being.

Cash flow from investing activities

CFI includes any inflows or outflows of cash from a company's long-term investments. This covers the cash spent on or received from buying and selling assets, like buildings and equipment, as well as money from investments in other companies and securities.

Some common examples of CFI include:

• Purchase of property, plant, and equipment (PP&E), also known as capital expenditures (CapEx)
• Proceeds from the sale of PP&E
• Acquisitions of other businesses or companies
• Proceeds from the sale of other businesses
• Purchases of marketable securities (e.g. stocks, bonds)
• Proceeds from the sale of marketable securities
• Making and collecting loans (except for program loans)
• Acquisition and disposition of debt or equity instruments

Understanding CFI is crucial for investors and financial professionals to assess a company's future prospects and financial health. A negative CFI does not always indicate poor financial health, as it could mean the company is investing in its long-term growth.

Long-term uses of cash

For individuals, long-term uses of cash can include investing in real estate, stocks, bonds, or other financial instruments. These investments are typically made with a time horizon of more than a year and can provide potential capital gains and ongoing income streams. For example, an individual might choose to invest in a portfolio of stocks and bonds, hold onto them for several years, and benefit from any dividends or capital appreciation.

Companies also engage in long-term uses of cash, which are reflected on their balance sheets. Long-term investments for companies may include stocks, bonds, real estate, and cash itself. These investments are intended to be held for more than a year and differ from short-term investments, which are meant to be sold within that timeframe. Long-term investments contribute to the financial stability and growth of a company, providing steady income through dividends, rental income, or capital appreciation.

Additionally, companies may use cash for long-term capital expenditures (CapEx) involving property, plant, and equipment (PPE). These types of investments are essential for future operations and business growth. For example, a company might invest in a new factory building to expand its production capacity, which would be considered a long-term cash outflow from investing activities.

In summary, long-term uses of cash involve allocating financial resources towards investments or capital expenditures with a time horizon exceeding one year. These decisions are made by both individuals and companies to achieve financial goals, such as capital appreciation, steady income, or business expansion.

Cash flow from operating activities

The cash flow from operating activities is an important benchmark for assessing a company's performance and liquidity. It helps business owners and investors understand the sources and uses of cash within the company. This information is vital for making efficient financing decisions, such as expanding operations, launching new products, paying dividends, or reducing debt.

There are two methods for depicting cash flow from operating activities: the indirect method and the direct method. The indirect method starts with net income, then adjusts for non-cash items and changes in working capital to arrive at a cash basis figure. On the other hand, the direct method tracks all transactions on a cash basis, reflecting actual cash inflows and outflows during the accounting period.

The indirect method is commonly used as it is simpler to prepare, aligning with the accrual method of accounting that most companies use. However, the Financial Accounting Standards Board (FASB) recommends the direct method as it offers a clearer view of cash flows. The direct method also requires a reconciliation report to check the accuracy of the cash flow from operating activities, making it less popular among companies.

The formula for calculating cash flow from operating activities can vary depending on the company and the reporting standards. However, a generic formula is: Cash Flow from Operations = Net Income + Non-Cash Items + Changes in Working Capital.

Overall, the cash flow from operating activities is a critical metric for understanding a company's financial health and liquidity, providing insights into the cash-generating abilities of its core business activities.

Cash flow from financing activities

Financing activities include transactions involving debt, equity, and dividends. This covers debt and equity financing, which vary according to a company's capital structure, dividend policies, and debt terms.

The formula for calculating CFF is:

> CFF = CED − (CD + RP)

>

> where:

>

> CED = Cash inflows from issuing equity or debt

> CD = Cash paid as dividends

> RP = Repurchase of debt and equity

For example, if a company's financing activities section of its cash flow statement includes the following:

• Repurchase stock: $1,000,000 (cash outflow)
• Proceeds from long-term debt: $3,000,000 (cash inflow)
• Payments to long-term debt: $500,000 (cash outflow)
• Payments of dividends: $400,000 (cash outflow)

The CFF would be calculated as:

> $3,000,000 - ($1,000,000 + $500,000 + $400,000) = $1,100,000

Positive CFF indicates more money flowing into the company, increasing its assets. However, this could be a warning sign if the company already has significant debt. Conversely, negative CFF could indicate that a company is servicing, retiring debt, or making dividend payments and stock repurchases, which can be viewed positively by investors.

Cash investments

• An individual's or business's direct financial contribution to a venture, as opposed to borrowed money.
• Short-term investments that earn interest, figured as a percentage of the principal.

There are four major types of cash equivalent investments:

• Certificates of deposit (CDs)
• US Treasury bills (T-bills)
• Bank money market accounts
• Money market mutual funds

Frequently asked questions