Cash flow from investing activities is usually the second section of a standardized cash flow statement commonly used across the world. As the name suggests, it enables an organisation to gauge how much money has been generated from investment-related expenditures.
Of all the major types of cash flows, this is an essential channel of data and information for a company. This is because investments are long-haul plans for the continued survival of any major company. Failed investments can be disastrous to a company’s financial health.
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Understanding Cash Flow from Investing Activities Better
The most common areas of investment for a company include sales of securities and/or assets -whether movable or immovable- and Intellectual Property, purchase of any particular physical assets and specific but fine-tuned investments in securities.
A positive cash flow from investments is a go-ahead for a company’s future ambitions. Often, major conglomerates rely almost entirely on this data before a staggered process of investing activities begins.
Before we delve deeper into this type of cash flow, it would be wise to understand exactly where investments fall in any company’s financial statements. Hence, some elementary pointers of financial statements must be mentioned here.
Across the world, thanks to agreed-upon accounting techniques, a company’s financial statement have 3 parts, namely:
- Income statement
- Balance sheet, and
- Cash flow statement
Of these, an income statement gives a bird’s-eye view of the expenses and revenues of an organisation over a given time.
A balance sheet provides detailed information on a company’s net assets, net liabilities, owners’ and promoter’s equity, among a variety of subheads.
Finally, a cash flow statement acts as a bridge between an income statement and a balance sheet. It shows how much money is required for the company’s day-to-day expenses, how much can be allocated for further refinements of a business plan, and also the size of the corpus that can be kept aside for investments in the future.
It is from this data that the C-Suite determines future investments.
Types of Cash Flow
Cash flow has 3 different subsets- working capital, investments and financing. In accounting terms, these entries are known as ‘activities.’
Here, we will focus mainly on the cash flow from investing activities.
Why do Companies Stress on Cash from Investing Activities?
In general accounting terminology, as well as in some macroeconomic circles, an investment is defined as the purchase of any non-fixed assets which can be used in the future. When the ‘right’ time arrives, a savvy Board of Directors (BoD) of any firm will monetize this asset.
For example, we can study the instance of Reliance Industries Limited (RIL), one of India’s largest corporate houses. Despite having a fully operational petroleum refinery in Gujarat’s Jamnagar, RIL chose to bid for the KG-D6 natural gas basin in the Krishna Godavari Basin.
This is a textbook case of an investment for an uncertain future. The KG-D6 basin is India’s largest-ever discovered pool of natural gas. When Jamnagar’s operations slow down, the basin will replace RIL’s extraction and other downstream activities.
Investing activities have several other cash flow channels. Two crucial ones are mentioned below.
- Changing the PPE bottom line: In investment parlance, PPE denotes Plants, Properties and Equipment. Any company looking for immediate cash infusion can sell or lease out these fixed assets.
- Alterations in Cap–Ex: Capital expenditure is a dead giveaway of a company’s financial performance. If investors find an entity is scouring global and domestic markets for immediate funding rounds, that entity’s market shares almost always gain in value. This is because a substantial increase in Cap-Ex is seen as a means of investments.
Positive and Negative Cash Flow from Investing Activities
Here are some examples of both positive and negative cash flow avenues from investments:
- Purchasing fixed assets – negative cash flow.
- Purchasing stocks, bonds, securities, debentures and other instruments – negative cash flow.
- Selling off or leasing out fixed assets, including plants and machinery – positive cash flow.
- Selling off securities within a brief time bracket – positive cash flow.
Cash flow from Investing Activities Formula –
There is no single, globally agreed-upon formula to determine cash flow from investing activities.
However, some experts agree on this simple equation:
|Cash flow = Total investment sum – losses + notional gains|
Cash Flow from Investing Activities Example –
The above-mentioned formula can be illustrated using an imaginary example.
Let us assume that a fictitious company, XYZ Pvt. Ltd., is engaged in manufacturing fertilisers. We have the following information made available via their stock market filings:
|Cash flow from investing activities||In Rs. Crores|
|Payment to set up their new plant||400 (Note: the remaining 50% will go to the non-cash side)|
|Infusion of extra cash for added construction||20|
|Proceeds from sale of the old facility||150 – 10= 140|
|Divestment in sister concern||50|
|Cash received from early loan settlement + interest||10 + 2= 12|
|Total cash flow via these investments||202|
Since the first 2 entries represent an outflow of cash, only the last 3 entries are considered here.
To sum, you can clearly understand that a company can gauge its Cap-Ex, future stability and other factors on cash flow from investing activities. However, there are other factors that a corporate major has to bear in mind before they go on a spending spree.
Innovation is the cornerstone of any successful company. Therefore, any organisation which fails to invest in potential future assets may fall behind its rivals. This is where this particular cash flow type comes in.