In the previous article of this series , we had taken a look at one of the components of cash flow statement — cash flow from investing activities. In this article, we shall discuss the last component of the cash flow statement — cash flow from financing activities.

Cash flow from financing activities

Under Account Standard 3 (or AS3), “Financing activities are activities that result in changes in the size and composition of the owners’ capital (including preference share capital in the case of a company) and borrowings of the enterprise.”

As you must be aware, a balance sheet is broadly made up of two components. One side shows what a company owns or controls (assets) and the other, what it owes (liabilities plus equity). In accounting terminology, it is termed as ‘Application of funds’ and ‘Sources of funds’. ‘Sources of funds’ indicate the total value of financing that a company has done. ‘Application of funds’ displays how a company has utilised these funds.

As such, one can say that ‘cash from financing activities’ is related to the ‘Sources of funds’ aspect of the balance sheet. This is where a company reports whether it took in money or paid out money to finance its activities.

Whenever a company changes the size or the structure of its ‘Sources of funds’, it is recorded under this cash flow head. As such, any increase in debt, be it long-term or short-term is recorded here. Similarly, transactions relating to repayments are also shown under this head. Interest costs relating to loans taken form a part of ‘cash flow from financing activities’ as well. This is because it is considered as the cost of obtaining financial resources or returns on investments.

Moving on, details relating to funds raised by issuance of more shares are recorded here. This may include proceeds from issuance of shares though preferential allotments and QIPs, amongst others.

It would also include increase in share capital through issuance of ESOPs. Cash transactions relating to repurchase or buyback of shares are shown under this head as well. The cash flow from financing activities also includes outflow of cash in the form of dividends. As dividend can be considered as a cost for obtaining financial services, it is required to be shown here.

Unlike the ‘cash flow from operations’, a positive cash flow from financing activities would not necessarily be a good thing. A positive cash flow from financing activities indicates that a company has taken on more debt or is diluting equity by issuing more shares. This is not necessarily something that would make an investor happy. Similarly, a negative cash flow would not also be harmful as it could mean that a company is paying out dividend (cash outflow).

Let us take up an example to understand this well. Shown in the accompanying table is the 'cash flow from financing activities' portion of Britannia's FY09 cash flow statement.

As you can see, there are some figures which are in brackets. This indicates that the money is going out of the company. On the other hand, the amounts which are not in brackets indicate the inflow of money. It must be noted that the figures in the above image are in Rs '000 (thousand).

During FY09, Britannia's cash outflow from financing activities stood at Rs 1.1 billion. This negative cash flow from financing activities is largely due to repayment of unsecured loans (Rs 3.1 billion). However, the company has also received certain funds from borrowings. The net figure, however, stands at a negative figure of Rs 396 m (Rs 3,063 m - 2,337 m - 330 m), indicating that the amount that was repaid was higher. In addition, due to interest payment and dividend payment (including the dividend tax), the overall net cash flow from financing activities increased to Rs 1.1 billion.

In the next article of this series, we shall look at some of the key ratios relating to cash flow statements.

(This article is authored by Equitymaster.com , India’s leading independent equity research initiative.)

Disclaimer: The opinions expressed by Equitymaster are theirs alone and do not reflect the opinions of The Hindu Business Line or any employee thereof. The Hindu Business Line is not responsible for the accuracy of any of the information within the article.

Related Topics
comment COMMENT NOW