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Money Management and Cash Generating Efficiency of a Business

Money Management and Cash Generating Efficiency of a Business

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Before the bull market ended in 2007, many companies had accumulated large amounts of cash. Exxon Mobil, Microsoft, and Cisco Systems, for example, had amassed more than $100 billion in cash. At that time, the average large company in the United States had 7 percent of its assets in cash.
Before the bull market ended in 2007, many companies had accumulated large amounts of cash. Exxon Mobil, Microsoft, and Cisco Systems, for example, had amassed more than $100 billion in cash. At that time, the average large company in the United States had 7 percent of its assets in cash.

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Published by: ClassOf1.com on Jun 12, 2013
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04/12/2014

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 Accounting
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Sub: Accounting Topic:
 
Financial Accounting
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Money Management and Cash Generating Efficiency of a Business
Before the bull market ended in 2007, many companies had accumulated large amounts of cash.Exxon Mobil, Microsoft, and Cisco Systems, for example, had amassed more than $100 billion in cash.At that time, the average large company in the United States had 7 percent of its assets in cash.Increased cash can be a benefit or a potential risk. Many companies put their cash to good use. Of course they are wise to have cash on hand for emergencies.They may also invest in productive assets, conduct research and development, pay off debt, buy backstock, or pay dividends. Sometimes, however, shareholders suffer when executives are tooconservative and keep the money in low-paying money market accounts or make unwiseacquisitions. For the user of financial statements, the lesson is that it is important to look closely atthe components of the statement of cash flows to see how management is spending its cash.
 Cash-Generating Efficiency
 Managers accustomed to evaluating income statements usually focus on the bottom-line result.While the level of cash at the bottom of the statement of cash flows is certainly an importantconsideration, such information can be obtained from the balance sheet. The focal point of cash flowanalysis is on cash inflows and outflows from operating activities. These cash flows are further usedin ratios that measure cash-generating efficiency, which is a company's ability to generate cash fromits current or continuing operations. The ratios that analysts use to compute cash-generatingefficiency are cash flow yield, cash flows to sales, and cash flows to assets.
Cash flow yield
is the ratioof net cash flows from operating activities to net income.The cash flow yield needs to be examined carefully. Keep in mind, for instance, that a firm withsignificant depreciable assets should have a cash flow yield greater than 1.0 because depreciation
 
 
Sub: Accounting Topic:
 
Financial Accounting
*
expense is added back to net income to arrive at cash flows from operating activities. If discontinuedoperations appear on the income statement and are material, income from continuing operationsshould be used as the denominator. Also, an artificially high cash flow yield may result if a firm hasvery low net income, which is the denominator in the ratio.
Cash flows to sales
are the ratio of netcash flows from operating activities to sales.Cash flows to sales and cash flows to assets are closely related to the profitability measures of profitmargin and return on assets. They exceed those measures by the amount of the cash flow yield ratiobecause cash flow yield is the ratio of net cash flows from operating activities to net income.

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