Cash flow and Budgeting

Important Terminologies:
 Financial Statements
Investors and financial analysts rely on financial data to analyze the performance of a company and
make predictions about the future direction of the company's stock price. One of the most important
resources of reliable and audited financial data is the annual report, which contains the firm's financial
statements.
The financial statements are used by investors, market analysts, and creditors to evaluate a company's
financial health and earnings potential. The three major financial statement reports are the balance
sheet, income statement, and statement of cash flows.
 Balance Sheet:
The balance sheet provides an overview of a company's assets, liabilities, and shareholders' equity as a
snapshot in time. The date at the top of the balance sheet tells you when the snapshot was taken, which
is generally the end of the reporting period. Below is a breakdown of the items in a balance sheet.
 Liabilities:
A liability is something a person or company owes, usually a sum of money. Liabilities are settled over
time through the transfer of economic benefits including money, goods, or services. Accounts payable
are the bills due as part of the normal course of operations of a business. This includes the utility bills,
rent invoices, and obligations to buy raw materials. Wages payable are payments due to staff for time
worked.
Part One: Cash Flow
Cash Flow (CF) is the increase or decrease in the amount of money a business, institution, or individual
has. In finance, the term is used to describe the amount of cash (currency) that is generated or
consumed in a given time period.
Uses of Cash Flow:
Cash Flow has many uses in both operating a business and in performing financial analysis. In fact, it’s
one of the most important metrics in all of finance and accounting.
The most common cash metrics and uses of Cash Flow are the following:
a) Net Present Value – calculating the value of a business by building a DCF Model and calculating
the net present value (NPV)
b) Internal Rate of Return – determining the IRR an investor achieves for making an investment
c) Liquidity – assessing how well a company can meet its short-term financial obligations
d) Cash Flow Yield – measuring how much cash a business generates per share, relative to its share
price, expressed as a percentage
e) Cash Flow Per Share (CFPS) – cash from operating activities divided by the number of shares
outstanding
f) P/CF Ratio – The Price Earnings Ratio (P/E Ratio) is the relationship between a company’s stock
price and earnings per share (EPS). The price of a stock divided by the CFPS , sometimes used as
an alternative to the Price-Earnings, or P/E, ratio
g) Cash Conversion Ratio – the amount of time between when a business pays for its inventory (cost
of goods sold) and receives payment from its customers is the cash conversion ratio
h) Funding Gap – a measure of the shortfall a company has to overcome (how much more cash it
needs)
i) Dividend Payments – Cash Flow can be used to fund dividend payments to investors
j) Capital Expenditures: Cash Flow can also be used to fund reinvestment and growth in the
business

Statement Of Cash Flow

Overview: Cash flow statement is a statement which shows the sources of cash inflow and uses of cash
out-flow of the business concern during a particular period of time. Cash flow statement explains the
inflow and out flow of cash during the particular period. The main objective of the cash flow statement
is to show the causes of changes in cash between two balance sheet dates. It indicates the factors
contributing to the reduction of cash balance in spite of increase in profit and vice-versa. In a cash flow
statement only cash receipt and payments are recorded. It starts with opening cash balance and ends
with closing cash balance.
Structure of Cash Flow Statement:
The main components of the cash flow statement are:
 Cash flow from operating activities
 Cash flow from investing activities
 Cash flow from financing activities

1. Cash from Operating Activities

The operating activities on the CFS include any sources and uses of cash from business activities. In
other words, it reflects how much cash is generated from a company’s products or services.
These operating activities might include:
 Receipts from sales of goods and services
 Interest payments
 Income tax payments
 Payments made to suppliers of goods and services used in production
 Salary and wage payments to employees
 Rent payments
 Any other type of operating expenses
In the case of a trading portfolio or an investment company, receipts from the sale of loans, debt, or
equity instruments are also included because it is a business activity.

2. Cash from Investing Activities:

Investing activities include any sources and uses of cash from a company’s investments. Purchases or
sales of assets, loans made to vendors or received from customers, or any payments related to mergers
and acquisitions (M&A) are included in this category. In short, changes in equipment, assets, or
investments relate to cash from investing.
Changes in cash from investing are usually considered cash-out items because cash is used to buy new
equipment, buildings, or short-term assets such as marketable securities. But when a company divests
an asset, the transaction is considered cash-in for calculating cash from investing.

3. Cash from Financing Activities

Cash from financing activities includes the sources of cash from investors and banks, as well as the
way cash is paid to shareholders. This includes any dividends, payments for stock repurchases, and
repayment of debt principal (loans) that are made by the company.
Changes in cash from financing are cash-in when capital is raised and cash-out when dividends are
paid. Thus, if a company issues a bond to the public, the company receives cash financing. However,
when interest is paid to bondholders, the company is reducing its cash. And remember, although
interest is a cash-out expense, it is reported as an operating activity—not a financing activity.
How Cash Flow Is Calculated
There are two methods of calculating cash flow: the direct method and the indirect method.

1. Direct Cash Flow Method

The direct method adds up all of the cash payments and receipts, including cash paid to suppliers, cash
receipts from customers, and cash paid out in salaries. This method of CFS is easier for very small
businesses that use the cash basis accounting method.

2. Indirect Cash Flow Method

With the indirect method, cash flow is calculated by adjusting net income by adding or subtracting
differences resulting from non-cash transactions. Non-cash items show up in the changes to a
company’s assets and liabilities on the balance sheet from one period to the next. Therefore, the
accountant will identify any increases and decreases to asset and liability accounts that need to be
added back to or removed from the net income figure, in order to identify an accurate cash inflow or
outflow.
Cash Flow Management:
Cash flow is defined as “ The journey of money through a company.” It represents the income and
expenditure of a firm. Cash flow is a measure of how much cash a business brought in or spent in total
over a period of time. Cash flow is typically broken down into cash flow from operating activities,
investing activities, and financing activities on the statement of cash flows, a common financial
statement. It is the statement, which involves only short-term financial position of the business concern.
No business person can ignore cash flow. Whether it is a company of small or large size, cash flow is
like their pulse. One must monitor it regularly to ensure that the company functions well and grows.
Many companies have suffered due to cash flow mismanagement which can result in various
unpleasant consequences. All businesses must preferably have a positive cash flow which means that
there should be more money coming in than going out.
Cash flow analysis helps you understand if a business’s healthy bank account balance is from sales,
debt, or other financing. This type of analysis may uncover unexpected problems, or it may show a
healthy operating cash flow. But you don’t know either way until you review your cash flow statements
or perform a cash flow analysis.
Conclusion:
Cash flow refers to money that goes in and out. Having a positive cash flow means there's more money
coming in while a negative cash flow indicates a higher degree of spending. The latter isn't necessarily
a bad thing because it may mean that you're investing your money in growth. But if your spending
becomes excessive, you won't have enough for a rainy day and you won't be able to pay your suppliers
or lenders. Whether you're running a business or a household, it's important to keep on top of your cash
flow. The cash flow statement (CFS) measures how well a company generates cash to pay its debt
obligations, fund its operating expenses, and fund investments.