Cash is King!

“Cash is the lifeblood of any organization“

Common Misunderstandings about Cash

• that rapid growth means that your business is doing fine

• that a good profit situation equals a good cash situation

• that just because your company is “making money“, is will be easy to receive a loan

Cash v Profits

• Profit vs Cash flow: accrual accounting vs cash accounting

  • Revenue is recognized when earned rather than when cash is collected

• Time difference between profit and cash flow: It is possible for a company to have a healthy net income (profit) but not have enough cash to pay its employees, suppliers, and loans.

  • e.g., large amount of revenue are in the form of credit sales (accounts receivables), so profits quite healthy on I/S while there is no cash until these receivables are collected

• Profit net income on the income statement is ultimately insignificant unless a company can translate its earnings into cash

• the main difference is based on the accrual accounting and the profit accounting

• There is time difference between the cash recipience and the profit generation

Overview of the Cash Flow Statement

• The cash flow statement provides information about cash receipts and cash payments during an accounting period

• It tells how the business has generated cash and how cash was used

• Cash flow statement is cash-based

  • By contrast, the income statement is accrual basis and reflects revenue when earned rather than when cash is collected

  • CF statement reflects cash receipts when collected as opposed to when the revenue was earned

• Different from the I/S, CF statement tells where the cash are generated and how they are spent . Track the sources and uses of cash may reveal potential problems of the company’s operation

• By examining the cash flow statement, analyst can answer such questions

  • Does the company generate enough cash from its operations to pay for its new investment, or is the companying relying on new debt issuance to finance them?

  • Does the company pay its dividends to common stockholders using cash generated from operations. from selling assets, or from issuing debt

Why We Need to Know These?

• To get a better understanding of the business structure/whether they are sustainable

• As getting cash from selling assets or borrowing could not be a long-term plan for a healthy and sustainable company

• So: the sources of cash is useful to evaluate liquidity, solvency, and financial flexibility

Table: How the Following Scenarios Will Affect the Cash Flow Statement

Layout of Cash Flow Statement

it is important to understand where in the business the cash is being generated and spent, so divided in to 3 sections

Usually:

• “+“ in operating activities: should be the main source of cash inflow for a healthy company

• “-“ in investing activities as need cash to invest in non-current assets to support operating activities: and could be “+“ when selling non-current assets, but this should not be a normal case

• “±“ in financing

Overview of Cash Flow Statement

Cash Flow from Operating Activities

Cash flows from operating activities are cash inflows and outflows directly related to earnings from normal operations

• Net cash provided/used by normal activities + cash inflow - cash outflow

• Interest & dividend: operation or financing? Different under IFRS & US GAAP

• IFRS: more flexible, could be both

• Operation cash outflows: in order to generate cash, companies undertakes activities such as manufacturing/purchasing inventories, paying employees (wages), paying rents, taxes, and other operating expenses

Cash Flow from Investing Activities

Cash flows from investing activities are cash inflows and outflows related to the acquisition or sale of long-lived productive assets and investments in the securities of other companies. That are, investment in fixed assets and financial assets

Cash Flow from Financing Activities

Cash flows from financing activities are cash inflows and outflows related to external sources of financing (owners and creditors) for the enterprise

Net Increase (Decrease) in Cash

the combination of the net cash flows from operating, investing, and financing activities must equal the net increase or decrease in cash

US GAAP vs IFRS have different treatment towards interest received/paid

2 Formats for Reporting Cash Flow from Operating Activities

• Direct Method

  • reports the net cash effect of each operating activity

  • more informative as it provides detailed information on cash inflow & outflow, encouraged by both IFRS & GAAP

• Indirect Method

  • starts with accrual net income from income statement, then eliminates noncash items to arrive at net cash flow from operating activities

  • more popular among companies, as it is deemed easier and less costly

  • net income (profit) ± adjustments for non items = net cash flow from operating