Cash-flow tells a story : how can cash-flow patterns assist analysts in investigating a company's financial health?
Cash has been called the lifeblood of a business. A company’s ability to generate cash from its activities is a critical determinant of its survival and growth. Moreover, companies that consume cash consistently are on the way to disaster. This makes the cash-flow statement a vital set of information for assessing financial health. It reveals a company’s ability to generate sufficient cash to repay loans, to fund expansion and to pay dividends, and also enables analysts to understand how much profit is realised in cash. Past research has established that there are distinct cash-flow patterns that can be associated with the life-cycle phases of companies. Life-cycle theory suggests that companies go through phases of start-up, growth, maturity and decline. In each phase they face different operational circumstances which give rise to different cash-flow patterns. This research, conducted at the University of Stellenbosch Business School (USB), used empirical data to show how analysts can study a company’s cash-related variables and ratios and, by comparing them with expected patterns, gain a broader understanding of the company and its relative level of maturity. The study found that listed South African industrial companies displayed predictable occurrences of cash-flow patterns associated with start-up, growing and mature enterprises. It also found that certain patterns are only sustainable over short periods. Companies exhibiting these are at the end of their life cycle, and will either disappear or be restructured.