Business
Cash Flow
Cash flow refers to the movement of money into and out of a business. It is a crucial measure of a company's financial health, indicating its ability to meet financial obligations, invest in growth, and generate profits. Positive cash flow means more money is coming in than going out, while negative cash flow indicates the opposite.
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11 Key excerpts on "Cash Flow"
- Lea R. Dopson, David K. Hayes(Authors)
- 2016(Publication Date)
- Wiley(Publisher)
Because management’s ultimate use of cash is often equally as important as how much cash is actually available to spend, for many investors and managers, a business’s free Cash Flow is an important measure of its economic health. Free Cash Flow is simply the amount of cash a business generates from its operating activities minus the amount of cash it must spend on its investment activities and capital expenditures. Thus, free Cash Flow is considered a good measure of a company’s ability to pay its debts, ensure its growth, and pay (if applicable) its investors in the form of dividends. A company with a large and positive free Cash Flow can grow and invest its excess cash in its own expansion or alternative investments or by returning money to the company’s owners. It is important to recognize that managers of a business can influ- ence their free Cash Flow by taking longer to pay their bills (thus preserving cash), aggressively collecting their accounts receivable (AR) (thus accelerating the receipt of cash), or putting off buying needed inventory (again preserving cash). In some cases, managerial accountants also have some leeway regarding which items are, and are not, considered capital expenditures. It is also important to recognize that a negative free Cash Flow is not always a bad thing. If, for example, a company is making large investments in property and equip- ment and these investments earn a high return in the near future, the strategy has the potential to pay off very well in the long run. If, however, a company has a consist- ently negative free Cash Flow, it will likely need to supplement its cash from other sources. This would entail borrowing funds or seeking additional investors. Because outside funding for a company is rarely unlimited, a company with a consistent and significant‐sized, negative free Cash Flow simply must turn that situation around or it could face the ultimate closing of the business.
- Michael Chibili(Author)
- 2019(Publication Date)
- Routledge(Publisher)
The Cash Flow statement (also called the statement of Cash Flow) 5.1 Cash in the business 5.2 Establishing Cash Flow statements 5.3 A worked example in the establishment of the SCF using the indirect method Companies can only survive if they have enough cash in hand to be able to take care of all their expenses. Cash is considered as the lifeblood of any business. Users of financial statements who assess only the statement of profit and loss to try and determine the financial health of the company might later on realize that their assessment may have been incorrect. Profitable companies have been known to have suddenly failed because they did not adequately manage their Cash Flows. An understanding of the importance and management of cash is a must if any company’s management would want to avoid sudden liquidity problems. Section 5.1 discusses the place of cash in a business, while at the same time differentiating profits from cash. Section 5.2 provides the rules in the establishment of the Cash Flow statement, while Section 5.3 is a worked example of the Cash Flow statement using one of the well established methods. 81 5 © Noordhoff Uitgevers bv 5.1 Cash in the business Cash is money, in the form of notes and coins, which constitutes payment for goods or services at the time of their purchase or consumption. Cash is not only cash in hand but also deposits and overdrafts which are commonly called cash equivalents. All transactions whether they are settled immediately or settled in the future are ultimately conducted by cash or cash equivalents. Just like all other assets, cash is an asset with the same properties like other assets, and also many more.
- Michael Chibili(Author)
- 2019(Publication Date)
- Routledge(Publisher)
5The Cash Flow statement (also called the statement of Cash Flow)
5.1 Cash in the business5.2 Establishing Cash Flow statements5.3 A worked example in the establishment of the SCF using the indirect methodCompanies can only survive if they have enough cash in hand to be able to take care of all their expenses. Cash is considered as the lifeblood of any business. Users of financial statements who assess only the statement of profit and loss to try and determine the financial health of the company might later on realize that their assessment may have been incorrect. Profitable companies have been known to have suddenly failed because they did not adequately manage their Cash Flows. An understanding of the importance and management of cash is a must if any company’s management would want to avoid sudden liquidity problems. Section 5.1 discusses the place of cash in a business, while at the same time differentiating profits from cash. Section 5.2 provides the rules in the establishment of the Cash Flow statement, while Section 5.3 is a worked example of the Cash Flow statement using one of the well established methods.5.1 Cash in the business
Cash is money, in the form of notes and coins, which constitutes payment for goods or services at the time of their purchase or consumption. Cash is not only cash in hand but also deposits and overdrafts which are commonly called cash equivalents. All transactions whether they are settled immediately or settled in the future are ultimately conducted by cash or cash equivalents. Just like all other assets, cash is an asset with the same properties like other assets, and also many more. The structure of the subsections is as follows:
No longer available |Learn moreHow to Read a Financial Report
Wringing Vital Signs Out of the Numbers
- John A. Tracy, Tage C. Tracy(Authors)
- 2020(Publication Date)
- Wiley(Publisher)
Part One FUNDAMENTALS 1 STARTING WITH Cash FlowS 4 Starting with Cash Flows Savvy business managers, lenders, and investors pay a lot of atten-tion to Cash Flows . Cash inflows and outflows are the pulse of every business. Without a steady heartbeat of Cash Flows, a business would soon have to go on life support—or die. So, we start with Cash Flows. Cash inflows and outflows appear in a summary of Cash Flows. For our example in Exhibit 1.1, we use a business that has been operating for many years. This established business makes profit regularly and, equally important, it keeps in good financial condi-tion. It has a good credit history and banks lend money to the busi-ness on competitive terms. Its present stockholders would be willing to invest additional capital in the business, if needed. None of this comes easy. It takes good management to make profit consistently, to secure capital, and to stay out of financial trouble. Many busi-nesses fail these imperatives, especially when the going gets tough. Exhibit 1.1 summarizes the company’s cash inflows and out-flows for the year just ended, and shows two separate groups of Cash Flows. First are the Cash Flows of its profit-making activities— cash inflows from sales and cash outflows for expenses. Second are the other cash inflows and outflows of the business—raising capi-tal, investing capital in assets, and distributing some of its profit to shareowners. We assume you’re fairly familiar with the cash inflows and out-flows listed in Exhibit 1.1. Therefore, we are brief in describing the Cash Flows at this early point in the book: Summary of Cash Flows for a Business ◆ ◆ The business received $51,680,000 during the year from selling products to its customers. It should be no surprise that this is its largest source of cash inflow. Cash inflow from sales revenue is needed for paying expenses. During the year the company paid $34,760,000 for the products it sells to customers.
eBook - PDF- Jerry J. Weygandt, Donald E. Kieso, Paul D. Kimmel, Barbara Trenholm, Valerie Warren, Lori Novak, Jerry J. Weygandt, Donald E. Kieso, Paul D. Kimmel, Barbara Trenholm, Valerie Warren, Lori Novak(Authors)
- 2016(Publication Date)
- Wiley(Publisher)
4. Analyze the Cash Flow statement. The Cash Flow statement must be read along with the other financial statements in order to adequately assess a company’s financial position. In addition, it is important to understand how the net change in cash is affected by each type of activity—operating, investing, and financing—especially when different companies are being compared. Free Cash Flow is a measure of solvency: it indicates how much of the cash that was generated from operating activities during the current year is available after making necessary payments for capi- tal expenditures. It is calculated by subtracting the cash used by investing activities from the cash provided by operating activities. 1. Discuss the usefulness, content, and format of the Cash Flow statement. The Cash Flow statement gives information about the cash receipts and cash payments resulting from a company’s operating, investing, and financing activities during the period. In general, operating activities include the cash effects of transactions that affect profit. Investing activities gener- ally include Cash Flows resulting from changes in long- term asset items. Financing activities generally include Cash Flows resulting from changes in long-term liability and shareholders’ equity items. 2. Prepare a Cash Flow statement using the indirect method. There are four steps to prepare a Cash Flow statement: (1) Determine the net cash provided (used) by operating activities. In the indirect method, this is done by convert- ing profit from an accrual basis to a cash basis. (2) Analyze the changes in long-term asset accounts and record them as investing activities, or as significant noncash transac- tions. (3) Analyze the changes in long-term liability and equity accounts and record them as financing activities, or as significant noncash transactions. (4) Prepare the Cash Flow statement and determine the net increase or decrease in cash.
eBook - ePub- Keith Checkley(Author)
- 2012(Publication Date)
- Routledge(Publisher)
1 Cash Flow AND BUSINESS
Cash Flows are normally reported in a Cash Flow Statement . In the United Kingdom this is prepared in accordance with Financial Reporting Standard (FRS) No. 1 - Cash Flow Statements. In countries that have adopted international accounting standards it is prepared in accordance with International Accounting Standard (IAS) No. 7 - Cash Flow Statements. The Cash Flow Statement is a relatively recent phenomenon. FRS 1 was issued in the United Kingdom in September 1991. IAS 7, having originally been called Statement of Changes in Financial Position, was revised in 1992 and retitled Cash Flow Statements. Prior to this the UK and many other countries required a Statement of Source and Application of Funds in the annual accounts which, while being a document that assisted in the analysis of Cash Flows, was not a Cash Flow statement and proved difficult to interpret.Ever since the joint stock company was invented in the 1800s it has been customary to offer shareholders an annual Profit and Loss Account and Balance Sheet. However, professional analysts have realized that Cash Flows are essentially a matter of fact and are therefore much less prone to accounting interpretation by managers and directors of companies. Consequently we are now seeing much more emphasis being placed on the identification and analysis of Cash Flows as opposed to the traditional approach of data derived from the Profit and Loss Account and Balance SheetSee overleaf for extract from FRS 1 - Illustrative exampleXYZ LIMITEDNote to the Cash Flow statement
Reconciliation of operating profit to net cash inflow from operating activities:1. Net cash inflow from operating activities
The identification starts with operating profit, and the next two items are depreciation and the (profit)/loss on sale of fixed assets, which are added back. The objective is to identify the cash generated from operations . This is normally achieved by adding back to operating profit all non-cash items
eBook - PDF- Christopher D. Burnley(Author)
- 2015(Publication Date)
- Wiley(Publisher)
When the inflows from financing and investing are limited, if a company is to remain in business, it must generate sufficient cash inflows from operating activities to make the principal, interest, and dividend payments associated with the financing activities, and to continue investing at appropriate levels in property, plant, and equipment and other long-term assets. 2. Do any of the items on the statement of Cash Flows suggest that the business may be having problems? For example, a large increase in accounts receivable may indicate that the company is having difficulties collecting its receivables. A large increase in inventories may indicate that it is having trouble selling its products. A large increase in accounts payable may indicate that the company is having difficulty paying its bills. Large disposals of property, plant, and equipment may indicate that it is contracting, rather than expanding. 3. Of the sources and uses of cash, which ones are related to items or activities that will continue from period to period, and which are sporadic or non-continuing? A large source or use of cash in one period may not have long-term implications if it will not continue in the future. To address this question, the historical trend in the Cash Flow data must be considered. While some users will be interested in what has happened to cash in the current period, most are likely to be more interested in predicting the compa- ny’s future Cash Flows. For example, a bank loan officer wants assurance that, if money is loaned to the company, the company will be able to pay it back. A stock analyst, on the Interpreting Cash Flow Information 227 N E W S There are a number of actions that management can take that improve a company’s cash flow from operating activities in the short term, but that may be detrimental to the com- pany over the long term.
eBook - PDF- Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield, Irene M. Wiecek, Bruce J. McConomy(Authors)
- 2019(Publication Date)
- Wiley(Publisher)
They are required to be disclosed elsewhere in the financial statements. 5 As discussed in What Do the Numbers Mean? 22.1, financial statement users can benefit by looking beyond indi- vidual amounts reported in the statement of Cash Flows, and considering patterns within the different Cash Flow activities. What Do the Numbers Mean? 22.1 Generally, companies move through several life-cycle stages of devel- opment, and each stage has implications for their Cash Flows. As the following graph shows, the pattern of flows from operating, financ- ing, and investing activities varies depending on the stage of the cycle. In the introductory phase, the product is likely not gener- ating much revenue, although significant cash is being spent to build up the company’s inventories. Therefore, operating Cash Flow is negative. Because the company is making heavy invest- ments to get a product off the ground, the Cash Flow from invest- ing activities is also negative. Financing Cash Flows are positive because funds are raised to pay for the investments and cover the operating shortfall. As the product moves to the growth and maturity phases, these relationships reverse. The product generates more cash from operations, which is used to cover investments that are needed to support the product, and less cash is needed from financing. So is a negative operating Cash Flow bad? Not always. It depends to a great extent on the product life cycle. Sources: Adapted from Paul D. Kimmel, Jerry J. Weygandt, and Donald E. Kieso, Financial Accounting: Tools for Business Decision Making, 5th ed. (New York: John Wiley & Sons, 2009), p. 606. Positive Negative Cash Flow Financing Operating Investing Decline Introductory Growth Maturity Phase 5 Note that an asset that is acquired and financed through a third party when the lender pays the seller directly is considered a cash inflow (financing) followed by a cash outflow (investing).
eBook - PDF- Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield, Irene M. Wiecek, Bruce J. McConomy(Authors)
- 2019(Publication Date)
- Wiley(Publisher)
It is investing this cash to expand the business. The fact that the company is able to raise funds in the capital markets by issuing shares indicates that the capital markets have faith in the company’s ability to prosper. As the company expands, it may be able to move to having the bulk of the money used to finance purchases of capital assets being generated from operations. This would mean that the company would not have to increase its solvency risk by issuing debt or further dilute its shareholders’ equity by issuing more shares. Telemarketing Inc. appears to be a successful company that’s expanding. Companies that generate cash from investing activities may be selling off long-term assets. This pattern generally goes with a company that is downsizing or restructuring. If the assets that are being disposed of are not needed, then it makes sense to free up the capital that is tied up. Sim- ilarly, if the assets being disposed of relate to operations that are not profitable, disposal reflects a good management decision. However, if the company must sell off core income-producing assets to generate cash, then it may be sacrificing future profitability and revenue-producing potential. This is obviously undesirable. So, Cash Flow patterns can reveal significant information. Free Cash Flow Finance 5.1.1 A more sophisticated way to examine a company’s financial flexibility is to develop a free Cash Flow analysis. This analysis starts with net cash provided by operating activities and ends with free Cash Flow, which is calculated as follows: Net cash provided by operating activities – Capital expenditures – dividends = Free Cash Flow 32 Free Cash Flow is the amount of discretionary Cash Flow that a company has for purchas- ing additional investments, retiring its debt, purchasing treasury stock, or simply adding to its liquidity. This measure indicates a company’s level of financial flexibility.
eBook - PDF- Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield, Irene M. Wiecek, Bruce J. McConomy(Authors)
- 2022(Publication Date)
- Wiley(Publisher)
Telemarketing appears to be a successful company that’s expanding. Companies that generate cash from investing activities may be selling off long-term assets. This pattern is usually seen in a company that is downsizing or restructuring. If the assets that are being disposed of, such as Telemarketing’s patents, are not needed, then it makes sense to free up the capital that is tied up. Similarly, if the assets being disposed of relate to operations that are not profitable, disposal reflects a good management decision. However, if the company must sell off core income-producing assets to generate cash, then it may be sacrificing future profitability and revenue-producing potential. This is obviously undesirable. So, Cash Flow patterns can reveal significant information. Free Cash Flow Finance A more sophisticated way to examine a company’s financial flexibility is to develop a free Cash Flow analysis. This analysis starts with net cash provided by operating activities and ends with free Cash Flow, which is calculated as follows: Net cash provided by operating activities – Capital expenditures – dividends = Free Cash Flow 32 Free Cash Flow is the amount of discretionary Cash Flow that a company has for purchas- ing additional investments, retiring its debt, purchasing treasury stock, or simply adding to its liquidity. This measure indicates a company’s level of financial flexibility. A free Cash Flow analysis can answer questions such as these: • Is the company able to pay its dividends without the help of external financing? • If business operations decline, will the company be able to maintain its needed capital investment? • What is the free Cash Flow that can be used for additional investments, retirement of debt, purchases of treasury stock, or additions to liquidity? Illustration 5.22 shows a free Cash Flow analysis for Nestor Corporation.
eBook - PDF- Carl Warren, Jeff Jones, Amanda Farmer, , Carl Warren, Carl Warren, Jeff Jones, Amanda Farmer(Authors)
- 2021(Publication Date)
- Cengage Learning EMEA(Publisher)
Noncash expenses such as depreciation are added back to net income. Gains and losses on the disposal of assets are added to or deducted from net income. Changes in current operating assets and lia- bilities are added to or subtracted from net income, depending on their effect on cash. 3. Prepare the “Cash Flows from (used for) investing activities” section of the statement of Cash Flows. Cash Flows from (used for) investing activities are reported below Cash Flows from (used for) operating activities on the statement of Cash Flows. The “Cash Flows from (used for) investing activities” section reports the cash inflows and outflows related to changes in a company’s long-term assets. 4. Prepare the “Cash Flows from (used for) financing activities” section of the statement of Cash Flows. Cash Flows from (used for) financing activities are reported below Cash Flows from (used for) operat- ing activities on the statement of Cash Flows. The “Cash Flows from (used for) financing activities” sec- tion reports the cash inflows and outflows related to changes in a company’s long-term liabilities and stock- holders’ equity. 5. Prepare a statement of Cash Flows. The statement of Cash Flows reports Cash Flows from (used for) operating activities followed by Cash Flows from (used for) investing and financing activities. The result of summing the net Cash Flows from (used for) operating, investing, and financing activities is the net increase or decrease in cash for the period. Cash at the beginning of the period is added to determine the cash at the end of the period. This ending cash amount must agree with cash reported on the end-of-period balance sheet. 6. Metric-Based Analysis: Describe and illustrate the use of free Cash Flow and Cash Flow ade- quacy in evaluating a company’s Cash Flow. Free Cash Flow measures the operating Cash Flow avail- able for a company to use after it purchases the prop- erty, plant, and equipment necessary to maintain its current operations.
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