Part 1: Cash Flow Analysis
Businesses use accounting systems to keep track of financial transactions. The system is capable of generating comprehensive statistical reports, including the sales made by a firm, the purchases, liabilities, and other reports. These reports are very useful to managers and other interested parties as they can use it to determine the performance of a firm. They can also use the set of data obtained from the accounting system to aid in the decision-making process. An investor who wants to invest and have shares in a firm will need the financial statement of the firm to evaluate the potential returns associated with the investment as well as the risks associated with an equity stake in the operation. Other than investors, creditors will utilize financial statements to evaluate the ability of a firm to repay any debt that is incurred. Managers, investors, and other external users use financial statements to make informed decisions.
According to the Corporate Financial Institute (N.d), there are three financial statements, which include the income statement, the balance sheet, and the cash flow statement. The income statement is the most detailed financial statement, and it contains detailed information. Thus, it is considered the most important among the financial statement. An income statement provides details on the revenue and the expenses incurred from its operations over a given period. The income statement is composed of four main components, which include gross profit, operating expenses, non-operating expenses, and non-operating revenues. Understanding an income statement is very important for investors as they can evaluate the profitability and future growth of a firm, which would help them decide if to invest in the firm or not.
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The balance sheet, which is also known as the statement of financial position, is a type of financial statement that provides information on the worth of a firm from a book value perspective. It provides an overview of assets, liabilities, and stockholder’s equity on a specific date. In order for the balance sheet to ‘balance,’ assets must equal liabilities plus equity. On the balance sheet, the assets are listed in order of liquidity, while liabilities are listed depending on the order of payment. There are two types of liabilities, short-term and long-term liabilities. Short-term liabilities, which are also referred to as current liabilities are financial obligations of the firm which are expected to be paid within a year, while long-term liabilities are expected to be paid after one year (Kenton & Hayes, 2019). When building a financial model, current liabilities are critical for modeling working capital.
The cash flow statements provide an overview of a firm’s cash inflows and outflows for a given period. Standard cash flow statements are composed of three parts: operating, investing, and financing. The operating cash shows cash generated from net earnings. Investing cash activities focus on assets and shows how firm purchase assets and gains from the invested assets. The investing and financing portion is closely tied with the capital planning of a company. The financing cash activities show proceeds from debts and stock insurance and cash payments for dividends and interest. The cash flow statement provides an overview of the increase and decrease in total cash in these three categories. Cash flow statements help investors analyze how effective the firm is utilizing its cash.
The statement of cash flows for ABC company indicates that the company has a positive cash flow. As indicated in its Cash Flow Statement, the company has a cash flow of $142,000 from its operations, and this is a good thing. The company’s Cash Flow from investing activities shows that the firm spent $40,900 on investing activities, and this is a good thing as well. It is good to see the company invest its capital on activities instead of saving it or sitting on it. Looking at the company’s financing activities, ABC company has spent $83,000 for obligations such as loans and dividends. From an investing standpoint, the ABC Company is doing well in paying its shareholders. This is a good thing, as potential investors would want to invest in a company that pays its shareholders. Overall, the company has a positive cash flow, and this means that it is making profits. This is because the company is using its cash effectively. Given that the company has positive cash flow and pays its shareholders, I advise Ms. Jennifer Logan not to sell her shares because she has a solid investment in her hands. As long as the ABC Company is financially sound, Ms. Logan should continue holding her equity position in the company.
Part 2: Executive Summary
The term ‘monetary policy’ refers to the policies implemented by the Federal Reserve to influence the amount of money and credit in the economy of the United States. The Federal Reserve uses monetary policy in order to regulate the supply of credit and money in the economy. They regulate financial intermediaries to ensure that they abide by the monetary policies. Financial intermediaries are a financial institution, such as banks insurance companies, and depository institutions, which act as middlemen between lenders and borrowers of money. These financial institutions utilize the savings made by people and companies to make loans and generate profit from it. They provide favorable transactions terms in the financial market, but when not regulated, their terms can be unfavorable to both the lenders/investors and borrowers. Thus, the Federal Reserve regulates the supply of credit and money in the economy to help achieve stable prices, full employment, and economic growth.
The time value of money (TVM), also referred to as present discounted value, is the concept that dollar available today is worth more due to its potential earning capacity than the dollar received in the future. This principle is widely used in finance to evaluate investments, savings, annuities, and loans. TVM draws from the notion that people favor to receive money today rather than in the future since a dollar received today has the potential to grow in value over a given period. This is because when the money deposited in banks, it starts to earn interest, and its value increases with time and is therefore said to be compounding in value.
Chen (2018) defines a savings rate as “the amount, expressed as a percentage or ratio that a person deducts from his disposable personal income to set aside as a nest egg or for retirement.” This rate can decline or increase depending on the economy of a nation. For decades, the savings rates in the U.S. For instance, the personal saving rates were in the range between 5 and 7% but decreased to 1 to 3% in the 21 st century (Chen, 2018). During the recession period, the saving rates in the U.S. increased and reached 8% but fell considerably. In March 2018, the savings rates in the U.S. was 3.1%. Compared to other nations, the savings rates in the United States are relatively low. The highest ever saving rate in the United States was 17% in May 1975, while in China was approximately 30% (Chen, 2018).
A company can finance its operations and growth in three different ways: profits, debts financing, and equity financing. A firm can generate its profit internally, but equity and debt financing are externally and is often controlled by the management. Although they both supply an organization with capital, there is a significant difference between debt and equity financing. Debt financing involves taking out a loan or issuing bond from a bank or other financial institutions to raise capital. Firms can accept long-term financing to purchase assets such as machinery, equipment, and other facilities. The interest payments of the firm on the debt are reported on the income statement as an operating expense. Lenders retain no control or have no control over the firm and have no claim to a firm’s profits beyond the initial financing agreement. The firm pays the loan plus profits in installments for the specified period as agreed in the financial agreement, and interest on the loan is tax deductible.
With equity financing, the lenders are given shared in the firm in exchange for capital. In this type of financing, the investor is not paid like in loan arrangement, but there is a cost to equity capital. The investors anticipate making an acceptable return that justifies the risk of the investment. If a firm fails to meet the expectations of the investors, the investors can share their ownership as well as decide to invest elsewhere. This may hinder future efforts of a company to raise capital. Typically, this type of financing is less risky compared to debt financing since there are no repayment obligations and company and equity investors share the risks.
Financial analysis refers to the process of evaluating the performance of a company. It involves analyzing whether an entity is profitable to warrant a monetary investment. When conducting financial analysis, financial analyst focuses on the income statement, balance sheet, and cash flow statement. These three financial statements are important as they are used to evaluate the performance of a company.
References
Chen, J. (2018). Savings Rates. [Online]. Available at: https://www.investopedia.com/terms/s/savings-rate.asp . Accessed 26 th May 2019.
Corporate Finance Institute. (N.d). What are the three financial statements? [Online]. Available at: https://corporatefinanceinstitute.com/resources/knowledge/accounting/three-financial-statements/ . Accessed 26 th May 2019.
Kenton, W., & Hayes, A. (2019). Liability Definition. [Online]. Available at: https://www.investopedia.com/terms/l/liability.asp . Accessed 26 th May 2019.
