Cash Flow from Financing Activities

What is Cash Flow from Financing Activities?

Cash Flow from Financing Activities is the net amount of funding a company generates in a given time period, used to finance its business. Finance activities include the issuance and repayment of equityEquityIn finance and accounting, equity is the value attributable to the owners of a business. The book value of equity is calculated as the difference between assets and liabilities on the company’s balance sheet, while the market value of equity is based on the current share price (if public) or a value, payment of dividendsDividendA dividend is the share of profits a shareholder receives, made on behalf of the corporation. When a company genearates a profit and accumulates retained earnings, those earnings can be either reinvested in the business or paid out to shareholders as a dividend. Types include: cash, common, preferred, stock, property, issuance and repayment of debtLong Term DebtLong Term Debt (LTD) is any amount of outstanding debt a company holds that has a maturity of 12 months or longer. It is classified as a non-current liability on the company’s balance sheet. The time to maturity for LTD can range anywhere from 12 months to 30+ years and the types of debt can include bonds, mortgages and capital lease obligations. Companies that require capital will raise money by issuing debt or equity, and will be reflected in this section of the cash flow statementCash Flow Statement​A Cash Flow Statement (officially called the Statement of Cash Flows) contains information on how much cash a company has generated and used during a given period. It contains 3 sections: cash from operations, cash from investing and cash from financing..

What’s Included in Financing Activities?

It’s important for accountants, financial analysts, and investors to understand what makes up this section of the cash flow statement and what financing activities include. Since this is the section of the statement of cash flows that indicates how a company funds its operation, it generally includes changes in all accounts related to debt and equity.

Financing activities include:

• Issuance of equity
• Repayment of equity
• Payment of dividends
• Issuance of debt
• Repayment of debt
• Capital/finance lease payments

Example of Cash Flow from Financing Activities

Below is an example from Amazon’s 2017 annual report and form 10-k10-KForm 10-K is a detailed annual report that is required to be submitted to the U.S. Securities and Exchange Commission (SEC). The filing provides a comprehensive summary of a company’s performance for the year. It is more detailed than the annual report that is sent to shareholders. In the bottom area of the statement, you will see the cash inflow and outflow related to financing.

Activities in financing are:

• Inflow: proceeds from issuing long-term debt
• Outflow: repayment of long-term debt
• Outflow: principal repayments of capital leaseCapital Lease vs Operating LeaseThe difference between a capital lease vs operating lease is a relatively advanced concept and is unlikely to come up in entry-level finance interviews. However, it is useful to understand the difference between the two types of leases and their respective accounting treatment. Capital leases are counted as debt. They obligations
• Outflow: principal repayments of finance lease obligations

As you can see above, Amazon had a net outflow of cash in two of the three years, and most of it was related to capital lease obligations. In 2017, there was a large inflow of cash related to issuing long-term debt. This debt was most likely required to keep the total cash balance steady on a year-over-year (YoYYoY (Year over Year)YoY stands for Year over Year and is a type of financial analysis that's useful when comparing time series data. Analysts are able to deduce changes in the quantity or quality of certain business aspects with YoY analysis. In finance, investors usually compare the performance of financial instruments on) basis since a lot of money was spent on investing activitiesCash Flow from Investing ActivitiesCash Flow from Investing Activities is the section of a company's cash flow statement that displays how much money has been used in (or generated from) making investments in a specific time period. Investing activities include purchases of long-term assets, acquisitions of businesses, and investments in marketable securities in 2017.

Capital Structure of a Business

Companies typically use a combination of debt and equity to fund their business and try to optimize their Weighted Average Cost of Capital (WACC)WACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt. The WACC formula  is = (E/V x Re) + ((D/V x Rd)  x  (1-T)). This guide will provide an overview of what it is, why its used, how to calculate it, and also provides a downloadable WACC calculator to be as low as possible. Whatever capital structureCapital StructureCapital Structure refers to the amount of debt and/or equity employed by a firm to fund its operations and finance its assets.  The structure is typically expressed as a debt-to-equity or debt-to-capital ratio. Debt and equity capital are used to fund a business’ operations, capital expenditures, acquisitions, a company thinks is appropriate, the impact of the financing decisions will flow through the cash flow statement.

Examples of financing decisions include:

• Fund the business entirely with equity
• Fund the business with a combination of debt and equity
• Recapitalize the business and change its capital structure (see leveraged recapitalizationLeveraged RecapitalizationA leveraged recapitalization occurs when an issuer turns to the debt markets to sell bonds and uses the proceeds to buyback equity.)
• Pay dividends or buyback sharesDividend vs Share Buyback/RepurchaseShareholders invest in publicly traded companies for capital appreciation and income. There are two main ways in which a company returns profits to its shareholders – Cash Dividends and Share Buybacks. The reasons behind the strategic decision on dividend vs share buyback differ from company to company

Applications in Financial Modeling

When building a financial model in Excel, it’s important to know how the cash flow from financing activities links to the balance sheet and makes the model work properly. As you can see in the screenshot below, the financing section is impacted be several line items in the model. Since this example is from a Leveraged Buyout (LBO) modelLBO ModelAn LBO model is built in excel to evaluate a leveraged buyout (LBO) transaction, which is the acquisition of a company that is funded using a significant amount of debt. The aim of the LBO model is to enable investors to properly assess the transaction earn the highest possible internal rate of return (IRR)., it has significant long-term debt, and that debt is repaid as quickly as possible each year.

Image: CFI’s LBO Financial Modeling Course.

Items impacting this company’s funding are the line of credit (also called a revolverRevolver DebtRevolver debt is a form of credit that differs from installment loans. In revolver debt, the borrower has constant credit access up to the maximum limit. The borrower can access any amount up to this limit at any time and does not have a specific term to pay the loan back.), debt, equity, and dividends. The only line items that are impacted in the forecast (2018 to 2024) are the repayment of debt and the drawing down on the line of creditRevolving Credit FacilityThis guide to a Revolving Credit Facility outlines how revolving credit works, and how to incorporate one in financial modeling in Excel. It has an established maximum amount, where the business has access to the funds when needed. This type of credit is mostly used for operating purposes and cash flow fluctuations.

Additional Resources

Hopefully, this has been a helpful guide to understanding how to account for a company’s funding activities. CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ designationFMVA® CertificationThe Financial Modeling & Valuation Analyst (FMVA)® accreditation is a global standard for financial analysts that covers finance, accounting, financial modeling, valuation, budgeting, forecasting, presentations, and strategy. , which can transform anyone into a world-class financial analyst.

To continue learning and progressing your career, these additional resources will be helpful:

• Balance Sheet ItemsBalance SheetThe balance sheet is one of the three fundamental financial statements. These statements are key to both financial modeling and accounting. The balance sheet displays the company’s total assets, and how these assets are financed, through either debt or equity. Assets = Liabilities + Equity
• Income Statement ItemsIncome StatementThe Income Statement is one of a company's core financial statements that shows their profit and loss over a period of time. The profit or loss is determined by taking all revenues and subtracting all expenses from both operating and non-operating activities.This statement is one of three statements used in both corporate finance (including financial modeling) and accounting.
• Operating Cash FlowOperating Cash FlowOperating Cash Flow (OCF) is the amount of cash generated by the regular operating activities of a business in a specific time period. The operating cash flow formula is net income (form the bottom of the income statement), plus any non-cash items, plus adjustments for changes in working capital
• Cash Flow from Investing ActivitiesCash Flow from Investing ActivitiesCash Flow from Investing Activities is the section of a company's cash flow statement that displays how much money has been used in (or generated from) making investments in a specific time period. Investing activities include purchases of long-term assets, acquisitions of businesses, and investments in marketable securities