09 What's Behind the Cash Flow Statement: Break Down the Common Cash Flow Profiles

Just as the human body requires a healthy bloodstream to thrive, a company needs strong cash flow to maintain its financial health and vitality.

Similarly, negative or insufficient cash flow can lead to various problems, just as poor blood flow can cause health issues in the human body.

Additionally, as different people may have varying blood flow patterns depending on their age, health status, and activity levels, different companies may have different cash flow profiles.

So what are the common cash flow profiles for companies?

There are eight cash flow profiles based on different combinations of inflows and outflows from investing, financing, and operating activities.

Today, we'll focus on the four types with positive cash flow from operating activities.

First, let's look at the situation when a company has a net cash inflow from all three sources.

Since the company's operations and investments can generate net cash inflow, it should have sufficient money on hand. But it still raises money from external sources.

In this case, there might be two scenarios to consider.

On the upside, the company might be bracing for a big project that needs money.

On the downside, however, this cash flow profile might signal the management has manipulated the company's financial statements to transfer capital, of which investors should be wary.

The second situation is when a company has net cash outflow from investing activities but positive cash flow from financing activities.

If this is the case, the company might be in the growth stage, as it needs to invest heavily to expand its business.

If it successfully improves its operations and grows bigger, it's likely to generate higher revenue and profits in the future.

But investors should also be aware of the risks if the expansion is not as smooth as expected.

Tesla's cash flow profile for the fiscal years 2018-2020 is a typical example of this type.

But for the fiscal years 2021-2022, the EV maker's cash flow from financing activities turned negative due to debt repayment.

This example also suggests a company's cash flow profile changes as it develops.

The third situation is when a company has net cash outflows from both its investing and financing activities. This company can be considered a cash cow.

That's because, on the one hand, it still invests in its business to expand and has the potential to grow.

But on the other hand, the company also has extra cash to return value to its shareholders or repay its debt.

If we sift through the financial reports for the fiscal years 2018-2022, many US-listed companies had such a cash flow profile, including Microsoft, Google, Apple, Johnson & Johnson, and Walmart.

The fourth situation is when a company has net cash inflow from investing activities but net outflow from financing activities. This is usually the case for mature companies.

They tend to have a stable business model and don't have to keep investing to expand.

They also have sufficient cash to sustain operations.

Oracle might be one of these companies.

It had a net cash inflow from operating activities for all four fiscal years from 2019 to 2022. Its cash flow from investing activities remained positive for three years out of four, while it had net cash outflow from financing activities for the same period.

All the above situations we mentioned have positive cash flow from operating activities.

For the remaining ones, their operating cash flow is negative.

Generally, startups or declining companies might have net cash outflows from operating activities.

Startups may have a promising future to look for, but most of them end up in failure.

We may name many tech giants that grow from startups, but this can be our survivorship bias.

Therefore, identifying the risks and opportunities of startups is not individual investors' but professionals' forte.

As for declining companies, they do not look attractive as investors don't expect their performance to improve.

As a result, we'll not go over these four situations because they're too risky for ordinary investors to invest in.

Let's now do a quick recap.

A stable cash flow indicates a company's financial health.

There are eight common cash flow profiles, and we focused on four of them.

By observing a company's cash flow, we can gain insights into its operations and development, and thus make more informed investment decisions.