In accounting and corporate finance, cash flow denotes the aggregate amount of money as well as cash-equivalents transferred out of and into the business. Fundamentally, a firm’ ability to build value for the shareholders signifies the capacity to create positive cash flows or optimize the long-term free cash flows (Zayed & Liu, 2014). Determining the uncertainty, timing, and amounts of cash flows act as one of the most general objectives of capital budgeting and financial reporting. Acknowledging the comprehensive statement of cash flow, which outlines financing cash flow, investing cash flow, and operating cash flow, is critical to examining an organization’s overall financial performance, flexibility, and liquidity ( Pae & Yoon, 2012) . As one of the most crucial aspects of successful running of a business, cash flows are important because they inform the company of where cash is spent, assist in focusing on making excess money, offer better key performance indices, and help in making different financing decisions ( Maravas & Pantouvakis, 2012) . Cash generation is particularly important because money becomes the payment method for the things making the business function, for instance, expenses such as raw materials, rent, stock, and employee salaries, among others.
Cash Flow Generation Process
Cash flows are often generated based on condition data described for every financial transaction. Where required, cash flows can also be generated based on business position and transactions that are upheld for a financial instrument. It is important to consider the financial data sources that should be included to produce a unique business perspective of cash flow ( Pae & Yoon, 2012) . Cash flows tend to consist of a group of financial flows that portray a specific flow of finances, for example, repayment, interest, and disbursement. Cash flow generation approaches are numerous, including revenue growth, operating margin, and capital efficiency ( Kaspina, Molotov, & Kaspin, 2015) . Revenue growth caters for items and procedures such as volume (returning customers, new customers, referrals, marketing leads, and new categories and products) and price (higher prices on existing merchandise and higher prices on new products). Cash flow from operating margin includes COGS (return management, automation, and better agreements with suppliers) and SG&A (shipping, overhead, payroll, and marketing budget). As a source of cash flow, capital efficiency entails PP&E (proprietary technology and higher return on assets) and inventory (buying efficiency, inventory management, and increase in inventory turns).
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Cash Flow Case Study and Analysis
The need to realize and maintain operational leverage in business requires robust understanding of investing aspects to generate cash flow. As a financial manager, there are specific decisions required in the attempt to sustain operational leverage ( Farshadfar & Monem, 2013) . The individual responsible for generating cash investments and cash flows is the financial manager. The company outlined in the case study contemplates investing in a new program that is expected to generate cash flows of $10,000 annually for five years. Additionally, the financial manager expects the project to produce $15,000 annually for another two years. After seven years, the financial manager expects to sell the assets produced by the project for $50,000, with the sale generating a minimum of 14% to pay the shareholders for the investment risks.
Several questions expressed in the case study requires comprehensive analysis. Firstly, the cash-generating items are cash flows from investing activities, including proceeds from equipment and property disposal (sale of assets) worth $50,000, $50,000 (cash flows of $10,000*5), and $30,000 ($15,000*2). From the proceeds of cash-generating items, the net present value of the terminal value associated with the project is computed as follows:
Terminal Value = 100%-14% =86%
Terminal Value = 86% of the projects present value
Project’s Value (value after the end of the seven years) = $50,000+$50,000+$30,000 = $130,000
Present Value of the Terminal Value = 0.86*130,000 = $111,800
Regarding the proceeds of the project’s terminal value, the most that the financial manager pay for the project is $20,000. The project will be consistent with the company’s objective assuming that the financial manager can invest $25,000. The primary objective of the firm is to increase the amount of cash flowing into the business. Capital efficiency needs of the business is catered for by investing activities described in the case study. The items have displayed the ability to increase returns on inventory and generate higher returns on assets. Although the project duration is limited, the returns are sufficient to fund the company operations, including shareholder dividends.
It is crucial to consider how the statements of cash flows complement other aspects of a company’s financial. For instance, the first line of the statement of cash flows (cash and cash equivalents and the end of the period) is represented merely as “cash and cash equivalents” below the current assets (first line) of the balance sheet. Additionally, the first number displayed on the statement of cash flow – consolidated net income – is represented on the income statement as “income from continuing operations.” Since the statement of cash flow only caters for liquid assets, it tends to adjust for the operating income to produce the operating income flowing in as cash and cash equivalents (Zayed & Liu, 2014). Amortization and depreciation are presented on the balance sheet to offer a realistic view of the lifetime value of the company assets.
Regarding the operating cash flows, reversal of the adjustments is conducted because they are always measured at face value (Zayed & Liu, 2014). Investments appearing as assets on the business’ balance sheet should be deducted because they are apparently paid using cash. The cash flow statement also considers foreign exchange, dividends, and debt repayments.
Conclusion
Cash flow refers to the decrease or increase in the financial amounts an individual or business possesses. As a financial term, cash flow is the amount of money that is consumed or generated in a specific duration. Several kinds of cash flows exist, with diverse uses for operating a business as well as conducting a financial analysis. Cash flows include Net Change in Cash, Free Cash Flow to the Firm (FCFF), Free Cash Flow to Equity (FCFE), and Cash from Operating Activities. Financial managers can increase the company’s cash flow using strategies classified into capital efficiency, operating margins, and revenue growth. Each of the available strategies to generate CF can be broken down further into efficient management of inventory, efficient property plant, and equipment (PP&E), lower SG&A, reduced cost of goods sold, higher item prices, and higher sales volume. Regarding the importance of cash flows in business operations, financial managers should often spend significant periods assessing the flow of finances as well as identify potential opportunities and problems. Individuals responsible for financial analysis and planning, accounting, and finance should pay close attention to every financial detail affecting the daily operations of the business organization.
References
Farshadfar, S., & Monem, R. (2013). Further evidence on the usefulness of direct method cash flow components for forecasting future cash flows. The international journal of accounting , 48 (1), 111-133.
Kaspina, R. G., Molotov, L. A., & Kaspin, L. E. (2015). Cash flow forecasting as an element of integrated reporting: an empirical study. Asian social science , 11 (11), 89.
Maravas, A., & Pantouvakis, J. P. (2012). Project cash flow analysis in the presence of uncertainty in activity duration and cost. International journal of project management , 30 (3), 374-384.
Pae, J., & Yoon, S. S. (2012). Determinants of analysts’ cash flow forecast accuracy. Journal of Accounting, Auditing & Finance , 27 (1), 123-144.
Zayed, T., & Liu, Y. (2014). Cash flow modeling for construction projects. Engineering, Construction and Architectural Management, 21 (2), 170-189.
