NEW YORK ( TheStreet ) — Cash is the lifeblood of most companies, and many a company has crumbled from a lack of it. Why is it then that the statement of cash flows is probably the least understood of the big three financial statements ( Getting Started: Fundamental Analysis )? It’s time to get in the know about cash flow.

What Is Cash Flow?

Simply put, cash flow is the movement of cash into and out of a company. This is significant, because cash coming into a company during, for example, a given year isn’t necessarily the same thing as revenue. The statement of cash flows eliminates this difference, taking us back to the actual movement of cash.

This difference is caused by accrual-basis accounting (in comparison, see cash-basis accounting). Under accrual accounting, revenue and expenses are recognized when the work has been performed — not when the cash is paid or received (for more on revenues and expenses, see What Is an Income Statement ). Because of this, it’s not uncommon for companies to book revenue long before the bank ever sees a single cent.

Classifying Cash Flows

The statement of cash flows divides these cash transactions into three different sections that tell investors what the transaction (known as an activity) was related to: operating. investing and financing.

Each of these sections can tell you a story about how the company is doing, both from a cash standpoint and in terms of its overall health.

Operating activities:

The operating section of the statement of cash flows tells you how cash changed hands as a result of a company’s operations. Anything that’s involved in what a company does to make money (for example, a shirt manufacturer making shirts) is considered an operating activity.

Unlike operating items on the income statement, the operating section includes things such as dividend income and gains or losses from the sale of investments. Even though such items are not part of operations per se, they’re included in this section because they’re part of the company’s income.

As an investor, you’ll want to see two things in the operating section: Cash inflows and cash outflows. Sure, a company that doesn’t have outflows sounds nice; lots of money coming in, none going out. But business is cyclical: Goods get sold, and materials get purchased to make more goods (and so on), so any healthy company should have a reasonable amount of both money coming in and money going out. Naturally, though, a positive net operating cash flow is a good sign.

Investing activities:

Like you, companies invest to make money. Unlike you, not all of these investments are in other entities; a company also has to reinvest in itself. For a company to grow, it has to spend money on upgrading things such as facilities, equipment and staffing — all of these cash flows are found under the investing section.

Companies do often invest in stocks of other companies, and this also belongs in the investing section. But while the profit made from selling a stock might look like an investing activity, it’s not. The actual initial investment is an investing activity, but when the stock is sold, the gain is income, and it counts as an operating activity.

The investing section of the statement of cash flow doesn’t necessarily have to have a positive net cash flow to be in good shape. Since spending money (cash outflow) helps the company in the long run, it’s perfectly acceptable to see a negative number at the bottom of the investing activities section.

Financing activities:

When companies need more money than they currently have, they raise it by engaging in financing activities. Financing generally comes in two forms: equity (stock) and debt (bonds). Each source of financing in any given period is listed in this section.

Also included in the financing activities section are the dividends you receive from the company as a shareholder. Since you’ve taken a role in financing the company by buying stock, companies that pay dividends view their payment as a sort of cost to maintain your financing in the company.

Generally speaking, you’ll see more financing inflows at newer companies that are growing at a faster pace than more-established ones.

Remember, those investing activities may grow the company, but they also take a whole lot of cash — that’s why they’re often paid for through financing.

Net Cash Flows = Cash Position

The net cash flows at the bottom of the statement of cash flows are the sum total of the effects of operating, investing and financing activities on a company’s cash position.

A strong cash position is important because it can say a lot about how liquid the company is and how secure its future is if it begins to fall on some tough times ( Booyah Breakdown: Liquidity ). When money’s not coming in, companies that can’t support themselves with cash and other assets often face the chopping block. A decent amount of cash on hand can help ensure that this won’t be the case.

Analyzing Cash Flows

Even though the statement of cash flows is less popular than its siblings — the income statement and balance sheet — it’s probably the easiest financial statement to look at to from an analysis perspective.

The statement of cash flows is a relatively simple document to understand. It tells you straight up how much cash a company spent (outflows) and how much cash it has (inflows). Naturally, when cash inflows are greater than outflows, it’s a favorable situation for a company.

Still, don’t let a little red ink (or a number in parentheses) in the investing section scare you off from a company. Remember, spending money on investing activities can be necessary for the greater (long-term) good of a company.

When you look at the statement of cash flows, ask yourself: Does this company need cash? A favorable operating cash-flow ratio and a decent proportion of investment-related financing are good signs.

The operating cash flow ratio measures how well cash covers current obligations. To calculate this ratio, divide cash flows from operations by current liabilities. With this ratio, a bigger number typically means a better business outlook.

Ideally, financing is mainly used for the purposes of investing in the company, not for operations. One way to check is by comparing the cash from financing with the cash used on investing activities. If these numbers are pretty close to each other, things look good. If these numbers are not close, I would want to know where the rest of that financing was going before I put my investment money in.

Despite not being as well known as the other financial statements, the statement of cash flows can be another effective way for you to measure a company’s pulse and overall health ( Getting Started: Fundamental Analysis ).

Jonas Elmerraji is the founder and publisher of Growfolio.com, an online business magazine for young investors.