Category: Cash Flow

In terms of financial activities, it is essential to realize not only the meaning of a statement of cash flows but also the types of its calculation. According to Lewellen and Lewellen (2016), in modern practice, two methods of calculating cash flows have become widespread – direct and indirect. The division of all cash receipts and expenses into three categories – primary, investment, and financial activities – is common to both methods.

In the direct way, the basis is the conversion of all the proceeds from sales into net cash profit by consistently accounting for income and expenses in monetary form. The indirect type is necessary in order to transform the firm’s net profit into a real monetary form. Changes in financial assets and their equivalents during the reporting period show the ways of covering net cash flows. As Bollerslev, Xu, and Zhou (2015) note, the indirect method is considered preferable from the point of view of companies’ financial management since it clearly reflects changes in the balance structure of enterprises’ activities. Therefore, this way of calculating may be the valuable source of receiving important data.

Also, it is significant to clarify the advantages that the study of cash flows provides. This procedure allows evaluating liquidity and the threat of bankruptcy, calculating the effectiveness of financing capital investments, and assessing the production and financial risks of a certain company and the investment qualities of its securities. According to Barth, Clinch, and Israeli (2016), investors are interested in cash flows as a basis for paying dividends, and lenders use them as a guarantee of debt repayment. Therefore, this system is beneficial for various stakeholders and may be introduced in different financial schemes.

References

Barth, M. E., Clinch, G., & Israeli, D. (2016). What do accruals tell us about future cash flows? Review of Accounting Studies, 21(3), 768-807. Web.

Bollerslev, T., Xu, L., & Zhou, H. (2015). Stock return and cash flow predictability: The role of volatility risk. Journal of Econometrics, 187(2), 458-471. Web.

Lewellen, J., & Lewellen, K. (2016). Investment and cash flow: New evidence. Journal of Financial and Quantitative Analysis, 51(4), 1135-1164. Web.

Companies tend to be involved in a variety of operations. Therefore, cash flow statements often address four major areas: investing, operating, financing activities, and supplementary or additional information (Klammer, 2018). This is the basic report as it reflects the company’s activities related to the production and distribution of its products and services. The other aspects mentioned above are not mentioned in all statements as some companies are not involved in certain operations (for instance, financing). In order to calculate operating cash flows, it is necessary to add net income, non-cash expenses, and working capital changes.

Investing activities are associated with capital assets and the corresponding operations. Since there is no strict guidelines and standards as to estimating assets, companies tend to choose different items as their assets (Robinson, Henry, Pirie, & Broihahn, 2015). Therefore, it is essential to review this aspect in detail when comparing organizations’ reports. Financing activities display firms’ operations with stock, as well as debt financing. Additional information is related to reporting the operations with various things without cash use. Income taxes and interest paid are included in this report.

Different people and groups benefit from reviewing cash flow statements (Atrill, McLaney, & Harvey, 2014). For example, accounting professionals need these documents to estimate whether the company can cover its current expenses. Creditors also need to analyze cash flow statements in order to make a decision and evaluate the companies’ ability to pay back. Investors need these reports to understand whether the company they are interested in can be competitive. Clearly, shareholders need to look into cash flow statements to evaluate their potential gains. Finally, employees and partners can also benefit from reviewing these documents as these groups will understand whether the company can pay for the provided services.

References

Atrill, P., McLaney, E., & Harvey, D. (2014). Accounting: An introduction (6th ed.). Melbourne, Australia: Pearson Higher Education AU.

Klammer, T. (2018). Statement of cash flows: Preparation, presentation, and use. Durham, NC: John Wiley & Sons.

Robinson, T. R., Henry, E., Pirie, W. L., & Broihahn, M. A. (2015). International financial statement analysis workbook (3rd ed.). New York, NY: John Wiley & Sons.

Financial statements are crucial for any enterprise as they reflect the actual state of a company’s budget. They are used by both business owners and investors to evaluate the actual efficiency of operations. According to Kennon (2018), the primary objective is to understand and calculate ratios, which allow determining the profitability of an enterprise. One of the approaches for creating and examining such statements is the balance sheet.

Cash flow is a subtype of a financial statement, which reflects the balance of a company’s financials. Akdeniz (2015) states that cash flow consists of “operating, investing, and financing activities” (p. 10). In a way, this report is similar to the income statement as both provide insight into performance measures and profitability.

The specific aspect, which distinguished cash flow from other financial statements, is that it does not reflect noncash operations. For instance, depreciation would not be included in such report. Additionally, it is especially crucial for small businesses to calculate their cash flow on a quarterly basis (“Cash flow statement,” n.d.). It is because adequate management of cash is necessary for an establishment to be able to pay the bills as required.

This type of financial statements is helpful in identifying a company’s ability to pay for its activities on a daily basis. It should be applied to determine the economic component in the short-term perspective. Inflows, outflows, and their management are the primary objectives for cash flow calculations (“Cash flow statement,” n.d.). It should be noted that a company, that is considered profitable by accounting standards would present adverse results in its cash flow calculations. Thus, it is essential to understand the value of a cash flow statement and ensure that a company calculates the ratios on a regular basis.

References

Akdeniz, C. (2015). Financial statements explained. Bad Bodendorf, Germany: First Publishing.

Cash flow statement. (n.d.). Web.

Kennon, J. (2018). How to read and understand financial statements. The Balance. Web.

Introduction

A statement of cash flows is a statement of a company’s financial position that reflects how cash inflows and outflows are impacted by changes in the balance sheet and income. Direct and indirect methods are two accounting treatments of the operating activities section of the statement of cash flows. They are identical in all respects, except the process by which they recognize cash flow from operating activities. The given report focuses on the nature of the indirect method, its importance, and objectives, as well as advantages and disadvantages.

Nature of the Indirect Method

The indirect method is a technique that is extensively used in accounting for reporting cash flows from operating activities. When preparing the statement of cash flows using the indirect approach, companies rely on the information provided in the balance sheet and the statement of consolidated income. The indirect method converts the net income that was calculated on the accrual basis into cash flow from operating activities by using several different adjustments for any difference in timing between entries based on accrual accounting and actual cash receipts. It is worth noting that the net increase or decrease in cash and cash equivalents calculated using the indirect method is equal to that calculated using the direct method.

Importance and Objectives of the Indirect Method

The indirect method is the basic accounting of cash inflows and outflows from the company’s operating, investing, and financing activities. It attempts to determine the actual cash flows during a certain period. Its importance is represented by its popularity among business entities. They are allowed to present a statement of cash flows under either direct or indirect methods (Atrill & McLaney, 2017). However, since the information needed for the generation of the statement of cash flows under the indirect approach can be relatively easily assembled from the balance sheet and the income statement, the majority of corporations prefer this representation over the direct one. Moreover, the utilization of the direct method provides for a supplemental disclosure and a reconciliation of net income.

Accounting Method

Under the indirect approach, the first item that is presented in the operating activities section of the statement of cash flows is net income, which is then adjusted. It is the changes in the assets and liabilities accounts, non-cash expenses, as well as non-operating losses and gains which are subtracted from or added to the net income (Hilton & Platt, 2016). Among the common components of the non-cash expenses are depreciation expense, depletion expense, and amortization expense. Changes in the asset accounts include changes in inventory, prepaid expenses, and accounts receivable. Changes in the liability account may contain accounts payable, income tax payable, accrued expenses, and unearned revenues.

For example, if an asset account increased, this may mean that a company purchased a new asset and paid for it in cash. Therefore, the net cash flow from operating activities will decrease by the amount of cash that a company paid to buy an asset. Net income can also be overstated on a cash basis if a company recognizes revenue for which cash has not been received. If an asset account decreased, this indicates that a company sold some of its assets and received cash. Thus, the net cash flow from operating activities will increase by the amount of cash that a company received.

Changes in a liability account impact net income in the opposite direction since liabilities have a credit balance instead of a debit balance. For instance, if the value of liabilities increased, the difference should be added to the net income. If an accounts payable balance increased, this means that a company purchased something without paying for it in cash. The formula for calculating net cash flow under the indirect method is as follows:

Net Cash Flow from Operating Activities = Net Income + Increase in Current Liabilities – Decrease in Current Liabilities + Decrease in Current Assets – Increase in Current Assets + Non-operating Gains – Non-operating Losses + Non-cash Expenses.

Table 1 shows an example of the operating activities section of the statement of cash flows generated using the indirect method.

Table 1. Cash Flows from Operating Activities.

Cash flow from financing activities shows the sources of cash flows which a company used for funding. Items that may be included in the financing activities section are payment of dividends, repayment of the debt, repurchase of stock, and proceeds from long-term debt. Cash flow from investing activities reflects how much money has been spent on or generated from buying or selling long-term assets, both physical and financial. Some examples of the transactions that may appear in this section are the purchase of stocks or securities, purchase of equipment, proceeds from property and equipment incentive, and sales of marketed securities. As has been mentioned before, these two sections of the cash flow statement are equivalent to those generated under the direct approach.

Information Provided to the Users

A cash flow statement prepared using the indirect method provides information about the amount of cash and cash equivalents that enter and leave a business entity during a specific period (usually a quarter or a year). Shareholders and investors may use this statement of a company’s financial position to get a general understanding of its performance and determine whether it is efficient in generating cash from its daily operations. The higher the amount of cash provided by a company, the more likely it that it will pay its short- and long-term debt obligations successfully.

The quality of the company’s earnings can also be determined by comparing the value of net income that is reported in the income statement to net cash from operating activities. It is considered that earnings are of high quality if net income is smaller than the net cash generated from operating activities. At the same time, a negative divergence between the reported amount of income and net cash from operating activities may be viewed as a reason for concern. Another thing that investors can pick from a cash flow statement is whether a company raises money (debt or equity) to fund its losses from operations or finance investments.

Advantages and Disadvantages

The indirect method of reporting cash flows has several advantages. Firstly, it gives readers a more systematic view of the company’s statements of financial position by establishing a direct relationship with the balance sheet and the income statement. Secondly, it shows a clear difference between a company’s cash holding position and the amount of profit that has been reported. Thirdly, it discloses non-cash expenses, thus giving users a better understanding of a company’s performance. Fourthly, the indirect approach proves to be less complex for reporting compared to the direct approach. However, the indirect method provides unnecessary details that may be confusing to readers. Also, in contrast to the direct method, it gives a less clear view of cash inflows and outflows.

Conclusion

In summary, the indirect method of the presentation of a statement of cash flows involves the adjustments of net income or loss for non-cash items. This approach is commonly used by companies as they need only the information from the other two statements of financial position, which are the balance sheet and income statement. However, despite a number of advantages that the indirect method has over the direct one, it offers a less transparent picture of the flow of cash in and out of business.

Benefits of the Project and Lessons Learned

The benefits of the project are associated with the comprehensive discussion of the preparation of cash flow statements using the indirect method. The majority of the aspects regarding the given approach have been discussed, and a clear review of its advantages and disadvantages has been provided. Besides, the indirect method has been compared to the direct one in order to make the report more holistic. Apart from learning how to prepare the cash flow statement under the indirect approach using the balance sheet and the income statement, it has been learned that even though non-cash transactions influence net income, they are not the sources of cash inflows and outflows.

References

Atrill, P., & McLaney, E. J. (2017). Accounting and finance for non-specialists (10th ed.). Harlow, UK: Pearson Education.

Hilton, R. W., & Platt, D. E. (2016). Managerial accounting: Creating value in a dynamic business environment (11th ed.). New York, NY: McGraw-Hill.

Introduction

Performing a SWOT analysis allows establishing the reasons of effective or ineffective work of the company, a particular action or a strategy. Any segmentation starts from a thorough analysis of the market conditions in which the company is working, and an evaluation of the possibilities and the threats that the company might face. In that sense, SWOT analysis serves as a starting point for such assessment. In this paper, A SWOT analysis will be performed on a particular approach in intentionally biasing cash flow estimates, as the estimation of the cash flow can be considered as the most important step in the capital expenditure evaluation process.

Analysis

It can be seen from the analysis that corresponding potential threats to the possible threats gives the company its main strength in ideal scenarios only, underestimating profit, and over estimating costs. In that sense, it can be seen that the company is in need of another scenario. The potential threats in intentional or intentional biases in cash flow cannot be justified in accordance to the potential opportunities and the established weaknesses.

A cash flow bias could tend keeping costs higher than the supplies, when a scenario of maximal profit is implied. Additionally, the risk of assigning competencies to managers in areas that they allocated more controllable resources, might result in imbalance in the company’s resources’’ allocation. In the case of large and complex projects, the biases in cash flow estimates might lead to significant consequences, where in the case of Polaroid which filed for bankruptcy is exemplary.

In that regard, SWOT analysis can be used in combination with cash flow forecast to set the strategy for the company. If the analysis is used to match the company’s goals and possibilities with its opportunities, then initially providing incorrect or biased information can cancel out the long-term planning and managing the company’s strategic directions, not to say that it is unethical. In one case, that the bias can be seen as acceptable is when the investors are over conscious, and thus underestimating the projects profit can be seen as an additional measure of security in planning the company’s resources.

In general, cash flow forecasting is a good way of planning and predicting the pattern of the company’s development as well as setting the efficiency of taking major investments. The usage of SWOT analysis provided in the aforementioned case of bias in cash flow estimation implied that the company should change its strategy.

References

Biases in Cash Flow Estimation (2009). Web.

Cash Flow Forecasting (2009). Web.

How to Perform a SWOT Analysis For Your Business (2009). Web.

Brown, G. (2006). Project Cash Flow versus Accounting Income. Web.

The values of ebitda for the three years are $38,000 for 2004, $48,790 for 2005 and $63,840 for 2006. Free cash flow had two optional definitions. One definition was the cash flow from operations minus the capital spending. The second definition was the cash flow from operations minus the capital spending and minus dividends (Almeida, Campello & Weisbach 3). The table below displays the free cash flow for Meriden Products for the three years.

Cash flow from operation shows positive values less than the values of free cash flows for the three years. Free cash flow for the three years shows a positive incremental growth as years go by. All the values of ebitda are greater than the cash flow from operations through the three years.

For the pessimistic scenario, the calculation of ebitda and free cash flow remains the same as in the previous calculations. The formula for ebitda will be ebitda=net income + depreciation and the formula for free cash flow is cash flow from operation less capital spending. The table below contains the results.

Ebitda

Free Cash Flow

For the pessimistic scenario, the ebitda value for the first year equals that of the corresponding cash flow from operations, and for the remaining two years, ebitda is less than the cash flow from operations. Cash flows from operation values are less than the free cash flows for the three years. Free cash flow for the three years shows a positive incremental growth.

The use of ebitda has both advantages and disadvantages which the table below shows.

The use of free cash flow poses advantages and disadvantages as the table below indicates.

If I were Jim, I would tell the president that pro-forma figures would require too much disclosure of sensitive and confidential information to third parties, such as the investor, about the firm’s financial performance (McDonald 1777). I would convince him that there is no need for pro-forma numbers.

Works Cited

Almeida, Heitor., Murillo Campello & Michael Weisbach. Cash Flow Sensitivity. New York: New York University. 2004. Print.

McDonald, Robert. Cash Flow from Operations- Do We Need Any Other Cash Flow Terms? Chicago: University of New Haven, 2010. Print.

Cash flow is how a business will receive and spend money at any particular time. In this essence cash flow is a determinant to various important decisions in the organization that have to be considered. They include investing, lending, basic business operations and other supplements.

One of the areas where cash flow is important is in basic operations of the business activity. Cash is received or used as a result of the business activities involved in a company. It includes cash gained as compared to the capital in the business. For an organization, its solvency has to be positive. In this case solvency is the state of not being in debt such that the company can sustain itself as noted by Bodie, Kane and Marcus (2004). In operations, we try to determine the things that the business needs to operate on. In my Example I will use the Sarova hotels where we have a worldwide customer base. In this case we have to maintain a constant supply of foodstuff with or without customers. By this, cash flow comes in the sustenance of the hotel to continue being in operation at any one moment in time including when we have an in surge of customers.

Cash flow is also important when we are making decisions on investments. Investments include changes in assets of the organization according to Epstein and Eva (2007). Changes may be in the form acquiring new assets or the sale of old ones. For example, when the Sarova group of hotels has run short of customers, it can invest in various fields such as accrual of luxurious facilities to entice the customers or get involved in more advertising locally or overseas. Companies with enough cash at hand are able to invest it back into the business to generate even more cash and make more profit.

Another important decision is in financing activities which basically entail reports on the issuance and probable repurchase of the company’s bonds and even stock. It can also encompass payment of dividends accrued on shares and stocks. Sarova hotel being a vast company may want to acquire some of its previously sold out shares or be involved with some charity details. This cannot happen if the company is almost at a dead end. Otherwise it has to be at a higher equity. For financing of any mode to take place the company must ensure that a high cash flow is maintained whether through soliciting for more cash from creditors or involving more credit in the business outsource as noted by Plewa and Friedlob (1995).

There are various activities that also do require more knowledge on cash flow. We will refer to them as supplements. According to Epstein and Eva (2007) these may include taxes, interests paid and other exchanges that do not involve cash. In my case, Sarova may want to organize an office end of the year party, pay off loans and other activities which are not necessarily in the day to day running of the business. In a way cash flow can be used to determine how much a company is worth. This is an essential decision to investors who may want to buy a company or potential sale of a company. It’s also useful when it is required to borrow loans from financial lending institutions.

References

1. Bodie, Z., Alex, K. and Marcus, J. (2004). Essentials of investments, 5^th ed. McGraw- Hill Irwin.
2. Epstein, B. and Eva, K. J. (2007). Interpretation and application of international financial reporting standards. John Wiley & Sons.
3. Franklin, J., Plewa, G & F, Thomas (1995). Understanding cash flow. John Wiley & Sons.

Summary

In his article ”Research on financial strategy based on cash flow” Wang focused on the advanced Chinese economy by analyzing the effect of cash flow-based policy on the companies’ performance. Wang measures the capital level of a company, depending on the cash flow, and examines its financial strategies (2021). Since many companies are in a cash-strapped environment with high sales rates, a change in financial strategy is needed to avoid cash gaps. Information about financial flows allows the management to measure the state of affairs connected with the company’s cash and analyze the problems in this area, controlling the organization’s performance (Wang, 2021). Wang suggests a negative correlation exists between company capital status and net cash flow from operating activities (2021). Companies need more control over their cash flow when setting up financial strategies. Sustainable business development is impossible without adjusting the financial plan to avoid a shortage of funds.

Reflection

In my opinion, the researcher comes to the correct general conclusions: financial strategy is essential for analyzing the effectiveness of an enterprise; the company’s financial statements are not always accurate. The financial component of the enterprise’s activity becomes vital for analyzing the strategy, starting to reach the same level as sales figures and other critical business characteristics (Ferry & Ricci, 2021). Determining the net cash flow from operating activities is one of the main ways to analyze the company’s problems and prospects, which seems absolutely correct.

It seems to me accurate that businesses are trying to explore not only the traditional indicators of success but also their financial flows. In the modern world, studying such data can give a company a competitive advantage. Therefore, I think it is imperative to consider all business performance aspects. Despite the apparent benefits, companies are unfortunately not always open in financial policy questions. Many firms are not ready for change, even though adaptability, in my opinion, is one of the most critical indicators of success in today’s market. It seems to me that for a compelling business organization, financial flows should become not just a digital indicator but part of the company’s culture, openness in this regard will increase the reputation and trust of customers.

References

Ferri, S., & Ricci, F. (2021). Financial Strategies for Distressed Companies: A Critical Analysis and Operational Tools. Germany: Springer International Publishing.

Wang, H. (2021). Research on financial strategy based on cash flow. In 6th Annual International Conference on Social Science and Contemporary Humanity Development (SSCHD 2020) (pp. 800-805). Atlantis Press.

Judging upon the latest cash flow statement of Blue Apron Holdings Inc., it is appropriate to note that, in general, the company’s profit has seen a decrease, albeit fairly gradual. In recent years, since 2018, its net income growth was reduced by two – starting at 49,9% in 2018 and ending at 24,4% in 2020 (MarketWatch). This is one of the main characteristics investors are advised to look at – a persistent, decreasing trend. However, this trend is incomplete without other factors, such as the depreciation of tangible assets, which can characterize a company as excellent at distributing its finances.

Subsequently, looking at Blue Apron’s investing activities would be useful for a potential creditor because it gives the idea of how a company sustains and manages itself. Despite last year’s results in that area still not being majorly positive, the activities of most interest are net investing cash flow growth and capital expenditures growth. The first one is a good criterion of how the company manages its investments in a crisis like 2020. Although its niche is in high demand during the pandemic, the company was quite modest with its revenue growth and expenses. The capital expenditures growth, marked at -14.8%, characterized it as being a mindful decision-maker in the critical time – the company is less likely to take a risk to invest in a new opportunity (MarketWatch). Therefore, it marks it as being a stability-oriented company, which is preferable for a creditor.

The business’ financing activities are characterized by a similar trend of decrease or little growth, except for a few positions in the chart. A huge increase is seen in net financing cash flow, which signals a higher rate of economic activity overall – this is a positive characteristic for creditors since none of them want to lend money to a withering business. Another important point for a creditor is the company’s change in long-term debt, which showed better results in the previous years, going from 194K in 2017 to 41K the next year (MarketWatch). However, this year a decrease is minimal for obvious reasons – this year’s results may not be as characteristic; the earlier ones have greater value for a relevant assessment.

References

Blue Apron Holdings Inc. (2021). MarketWatch, Web.

At some point, many companies are frequently required to make particular funding decisions related to specific projects for profit and further successful development. However, it is essential to analyze the expediency of investments and the possibility of the cash flow’s increase. Thus, planning to be involved in any new project, a company should address incremental cash flow that may be defined as the cash flow acquired by it in the case of the project’s undertaking (Best, 2021). In order to evaluate incremental cash flow, a company should compare expected cash flows if it invests in a project and if it does not. The impact of the project’s acceptance on other business parts’ cash flow should be taken into consideration as well.

At the same time, there are several concepts essential for the understanding and estimation of incremental cash flow that should be considered during its analysis. These concepts include sunk costs, opportunity costs, allocated costs, and cannibalization. Sunk costs are already incurred costs that should not be included. In turn, opportunity costs refer to missed revenue chances from a business’ assets. Allocated costs refer to specific projects or departments, and their inclusion in the computation is optional. Finally, cannibalization addresses the situation when a new project reduces any previously taken project’s cash flows.

It goes without saying that there are multiple factors that should be considered as well in the analysis of incremental cash flow. They are changes in regulations, market trends, the company’s adjustment to legal policies, and cash flow modifications on the basis of business operations. In addition, several components should be identified for incremental cash flow evaluation, including the project’s timing and scale, the initial outlay, and terminal value or cost. Moreover, a company should identify its business revenue, list the project’s initial costs, record business expenses, and compare the differences.

Reference

Best. (2021). Incremental cash flow: Meaning, calculations, importance, and limitations. Business Yield. Web.