Preparing and Analyzing a Common Size Cash Flow Statement

A common size cash flow statement is a financial tool that reframes a company’s cash flow data for easier analysis. Instead of using raw dollar amounts, each line item is converted into a percentage of a single base amount, which is the company’s total revenue for the period. This standardization removes the distorting effects of company size, allowing for more direct comparisons. An analyst can compare a company’s performance over several years to identify trends or compare it to other businesses in the same industry, revealing operational efficiencies that dollar figures might hide.

Preparing a Common Size Cash Flow Statement

To prepare a common size cash flow statement, you need the company’s standard statement of cash flows and its income statement for the same period. The base for the calculation is total revenue, as this links a company’s sales generation to its ability to produce cash.

The conversion uses a single formula for every line item: (Cash Flow Line Item / Total Revenue) 100. This process is applied to all operating, investing, and financing activities, resulting in a statement where every number is a percentage of total revenue instead of a dollar amount.

For example, consider a company with $2 million in total revenue. Its standard cash flow statement might show Net Income of $200,000 and a non-cash Depreciation expense of $100,000. The investing section could show a Purchase of Equipment as a cash outflow of $150,000, while the financing section shows Net Borrowing of $50,000.

Applying the formula, Net Income becomes 10% of revenue ($200,000 / $2,000,000), and Depreciation is 5% ($100,000 / $2,000,000). The Purchase of Equipment is a cash use of 7.5% of revenue ($150,000 / $2,000,000), and Net Borrowing is a cash source equal to 2.5% of revenue ($50,000 / $2,000,000). This view presents cash flow activities relative to sales volume.

Analyzing Cash Flow from Operations

The operating activities section shows the cash-generating efficiency of a company’s core business. Presenting net income as a percentage of revenue shows how much of each sales dollar is converted into profit. A high or rising percentage suggests strong profitability, while a low or declining percentage may indicate pressure on profit margins.

The analysis also examines the adjustments that reconcile net income to net cash flow from operations. Non-cash charges like depreciation are added back to net income. When viewed as a percentage of revenue, a large depreciation figure might suggest a company has a significant investment in fixed assets, which could imply high future replacement costs.

Changes in working capital accounts are also informative. A large negative percentage for an increase in Accounts Receivable means the company is making sales on credit that have not yet been collected in cash. An increase in Accounts Payable, shown as a positive percentage, indicates the company is using supplier credit to finance its operations and preserve cash.

By viewing these items as percentages, an analyst can assess the quality of a company’s earnings. A company might report strong net income, but if its operating cash flow is much lower, it could be a red flag. This discrepancy may indicate that profits are tied up in uncollected receivables or slow-moving inventory.

Analyzing Cash Flow from Investing Activities

The investing activities section shows a company’s strategy for long-term growth and asset management. The primary line item is capital expenditures, or the purchase of property, plant, and equipment (PP&E). As a percentage of revenue, this figure shows how much of the company’s sales are reinvested into its productive assets. A high percentage can signal a growth phase, while a low percentage might suggest the company is scaling back investment.

Other investing activities, like the purchase or sale of businesses or securities, also provide context. A large positive percentage from selling assets could mean the company is divesting non-core operations to raise cash. While this provides a one-time cash boost, a recurring trend of selling assets to fund operations may indicate financial weakness.

Analyzing Cash Flow from Financing Activities

The financing section shows how a company manages its capital structure and returns value to owners. A large positive percentage from issuing debt shows a reliance on borrowing, which could be for expansion or to cover shortfalls. A large negative percentage from repaying debt indicates a focus on reducing leverage.

Actions related to equity are also shown here. Cash inflows from issuing stock provide capital without adding debt. Cash outflows for paying dividends or buying back stock are represented as negative percentages and show a direct return of cash to shareholders, which can signal confidence in the company’s financial stability.