Business Finance Week 4 – Flow of Funds & Role of the Financial Manager

Objectives of the Lesson

• By the end of Week 4 you should be able to:

  • Identify and classify business transactions as cash inflows or outflows.

  • Compute ending cash balances for each of the three cash‐flow sections and for the whole period.

  • Describe the complete flow of funds inside a business and explain the eight main duties of a financial manager.

Key Terms & Core Definitions

• Funds

  • All financial resources (current and non-current) available to a firm.

  • Sometimes equated with working capital ($\text{Current Assets} - \text{Current Liabilities}$) or strictly with cash & cash equivalents.

• Cash & Cash Equivalents (CCE)

  • Cash on hand, demand deposits, and short-term, highly liquid investments that are easily convertible to known amounts of cash and subject to insignificant value risk (e.g., Treasury bills, commercial papers).

• Flow of Funds (FoF)

  • Macro-level accounts that track net inflows and outflows among sectors of an economy.

• Statement of Cash Flows (SCF)

  • A financial statement that summarizes all cash receipts (inflows) and disbursements (outflows) for a specific period, separated into Operating, Investing, and Financing sections.

Why Cash Matters

• “Cash is the lubricant of the firm’s operations.”

• Proper cash analysis tells management:

  • Where cash comes from.

  • Where cash goes.

• Finance managers rely on cash to:

  1. Pay obligations as they fall due.

  2. Fund day-to-day operations and growth projects.

  3. Reward owners (dividends/withdrawals) for the risk they bear.

Three Basic Cash-Flow Activities

• Operating Activities

  • Cash effects of transactions that generate revenues and expenses.

  • Healthy firms show \text{Cash In} > \text{Cash Out} in operations.

• Investing Activities

  • Cash related to acquisition or disposal of long-term assets and investments.

  • Major line item: Capital Expenditures (CapEx).

• ### Financing Activities

  • Cash obtained from or returned to capital providers (owners & creditors).

  • Heavy reliance on debt increases long-term risk and can erode profitability.

Typical Transaction Classification (Inflow vs Outflow)

• Inflow Examples

  • Sale of merchandise / services rendered.

  • Collection of accounts receivable.

  • Owner’s investment / issuance of shares.

  • Borrowed funds / loan proceeds.

  • Sale of fixed assets.

• Outflow Examples

  • Purchase of machines or merchandise.

  • Payment of expenses (wages, utilities, etc.).

  • Payment of dividends.

  • Repayment of loan principal.

Financial Resources – Illustrative List

• Cash on hand & at bank

• Treasury bills

• Commercial papers

• Working-capital loans

• Short- & long-term bank loans

• Vendor or trade credit

• Corporate/government bonds

• Equity capital

The Eight Key Roles of a Financial Manager

1. Estimate the Amount of Capital Needed

   • For fixed assets, working capital, modernization, expansion (short- & long-term).

2. Determine the Capital Structure

   • Optimal mix of equity vs. debt; short-term vs. long-term financing.

3. Choose the Source of Funds

   • Stockholders, banks, bond markets, private lenders, etc.

4. Procure the Funds

   • Time the market, minimize cost, comply with policies, match investor preference.

5. Utilize the Funds

   • Invest prudently, ensuring safety, profitability, liquidity.

6. Dispose of Profits / Surplus

   • Decide on retention vs. dividend payout.

7. Manage Cash

   • Avoid both shortage and idle surplus; fund purchases, wages, day-to-day needs.

8. Exercise Financial Control

   • Monitor ROI, perform budgetary control, cost control, internal audit, break-even, ratio analysis.

     • $\text{ROI} = \frac{\text{Net Profit}}{\text{Total Investment}} \times 100\%$

Numerical Illustration – Union Company (2023)

• Cash Inflows

  • Customers $160{,}000$

  • Collection of Receivables $80{,}000$

  • Sale of Old Furniture $4{,}500$

  • Sale of Obsolete Equipment $8{,}750$

  • Interest Earned $850$

  • Owner Investment $60{,}000$

  • Bank Loan Proceeds $100{,}000$

• Cash Outflows

  • Payments to Suppliers $(75{,}000)$

  • Operating Expenses $(48{,}500)$

  • Office Computer Purchase $(65{,}000)$

  • Loan Principal Payment $(95{,}000)$

• Computed Statement of Cash Flows

  • Net Operating $116{,}500$

  • Net Investing $(51{,}750)$

  • Net Financing $65{,}850$

  • Net Change in Cash $130{,}600$

  • Beginning Cash $13{,}000$ → Ending Cash $143{,}600$

Quick Guide: Preparing a Statement of Cash Flows

1. Categorize every transaction into O, I, or F.

2. Add up all inflows and outflows in each category.

3. Net each section: $\text{Net Cash} = \sum \text{Inflows} - \sum \text{Outflows}$

4. Combine the three nets to arrive at Net Change in Cash.

5. Reconcile: $\text{Ending Cash} = \text{Beginning Cash} + \text{Net Change}$

Practice Problem Snapshot (Assignment Due 29 Aug 2024)

• Beginning Cash $8{,}900$

• Transactions include services rendered, rent income, salaries, dividends, equipment purchases, bond issuance, borrowing, withdrawal, etc.

• Required: Prepare full SCF & compute net cash for each section plus ending cash.

Case Analysis – “Balls on the Go”

Use Alessandro’s story to spot at least eight decisions and tag each as Financing, Investing, or Operating. Clues:

• Borrowing capital from uncle (Financing)

• Buying cart vs. renting (Investing decision that also lowers Operating costs)

• Switching suppliers with 15-day credit (Financing via trade credit & Operating efficiency)

• Sharing profit to uncle (Financing – profit distribution)

• Expanding with a second stall (Investing)

• Hiring Armand (Operating / Human-capital investment)

• …and more; list as many as you find.

Connections, Implications & Exam Tips

• SCF links income statement (profit) and balance sheet (assets, liabilities) via cash.

• Persistent negative Operating Cash Flow is a red flag even when net income is positive.

• Heavy Financing inflows can mask weak operations; always examine debt ratios.

• CapEx spikes in Investing may signal growth—understand strategic context.

• Memorize common inflow/outflow items; expect multiple-choice classifications.

• Show all computations clearly and always reconcile ending cash—markers look for that final check.

End of Study Notes – Week 4