ACC10007 Lecture Notes - Lecture 7: Current Asset, Inventory Turnover, Asset Turnover
Lecture 7 - Accounting For Decision making
Analyzing and Interpreting Financial Statements
Evaluation of Cash Flow statements
The cash flow statement provides stakeholders with information about the cash flows of
the entity. It helps in the evaluation of its potential to:
•generate cash to meet operational commitments
•generate cash flows to fund activities and investments
•meet its financial commitments
•obtain finance
•return a share of the profits to its owners
Cash flow From operating Activities
•Cash flow from operating activities is often considered the most important cash
activity.
•It represents the ability of the business to meet day to day operating commitments
and to generate cash to fund investment and finance obligations.
•In the long term a business cannot rely on debt and owner investment to sustain the
operations.
Implications of operating Cash Flows
•Positive operating cash flows can be reinvested to grow business. A healthy business
should generate positive net cash flow from operating activities and should grow
the amount over time.
•Just because a company shows a profit on the income statement doesn’t mean it
cannot get into trouble later because of insufficient cash flows. A close
examination of the cash flow statement can give investors a better sense of how
the company will fare.
•If a business fails to consistently generate positive net cash from operating activities, it
may need to rely on outside financing to operate, which will not sustain a business
long term.
Cash Flow patterns over the life of companies
•The initial phase a company goes through. This phase is typically characterized by
negative cash from operations, negative cash from investing, and positive cash
from financing.
•The second phase that a company goes through. This phase is typically characterized
by small positive amounts of net cash provided by operating activities.
Furthermore, the company still shows negative cash from investing and positive
cash from financing.
•During maturity phase net cash generated from operations exceeds investing needs
and the company starts to pay dividends and retire bonds
Cash Flow from Investment Activity
•The important thing to notice is how the company has used the cash it has generated
mostly from operations. Focus on the investing activities section, which normally
shows a net use of cash.
•If the firm is kept whole and is not shrinking, we should expect the portion of investing
activities related to the purchase of fixed assets to exceed depreciation.
•A shrink business may generate much of their cash by selling off fixed asset which will
be reflected in investment activities.
Cash Flow from Financing Activities
Cash flows from financing activities could be positive or negative in a healthy company.
Moreover, they are likely to change back and forth, so finding the “good” and “bad”
is more challenging.
A bad scenario might be that the company has low (or negative) cash flows from
operations and is being forced to generate funds from other sources.
A good scenario might be that a new start-up is doing well enough to issue an Initial
Public Offering.
Raven Enterprises 2017 2016
Cash Flow from Operating Activities
Receipts from Customers $ 96,000 80,000
Payments to Suppliers (66,500) (50,400)
Payments to Employees (17,000) (15,000)
Payments for Other Expenses ( 500) ( 3,600)
Net Cash Flow from Operating Activities 12,000 11,000
Cash Flow from Investing Activities
Purchases of Non Current Assets (11,000) ( 1,500)
Receipts from Sale of Non Current Assets - 2,000
Net Cash Flow from Investing Activities (11,000) 500
Cash Flow from Financing Activities
Proceeds from Long Term Borrowing 1,000 -
Repayment of Long Term Borrowings - ( 4,000)
Drawings ( 5,000) ( 6,500)
Net Cash Flow from Financing Activities ( 4,000) (10,500)
= Total Net Cash Flow for the Period ( 3,000) 1,500
+ Bank at beginning 2,000 500
= Bank at end $ ( 1,000) 2,000
Observations from Raven Enterprise-!
Operating cash flow
•It seems a mature business growing with a degree of stability as cash from operation
has grown. Payment to suppliers has increased could indicate start of a better
supplier relation and better positioned to negotiate better trading terms.
•Increase in purchase of non-current asset indicates growth intention of a business.
Sale of non-current asset has declined in 2017. This could indicate old assets has
been already replaced.
•Repayment of long term borrowing in 2016 indicates that company achieved better
Debt to Asset ratio and positioned better to find debts at a better rate. This has
been reflected in 2017 while this business took more debt.
Use of cash flows to determine business valuation
Free cash flows, that is cash generated from operation can be used to find value of a
business.
