UNDERSTANDING THE CASH FLOW STATEMENT (part 2)

This is the concluding part of the post where effort will be made at interpreting the 3 core areas of the Cash flow statement and its effect on the business. some questions also need to be answered honestly and corrections made to remain viable, liquid and successful..

INTERPRETATION

·        Operating

It helps to determine if a company is generating sufficient revenue/cash/income from its core operations to support its activities or needs directly related to the daily operations or needs further injection of funds. Negative cash flow (when outflow far outweighs the inflow) should not raise any alarm but if uncorrected over a long period could be dangerous and might eventually lead to the collapse of such business or project.

This negative Cash flow could be as a result of low sales, more emphasis on credit to push sales and/or delay in the collection period (number of days it takes to cash the receivables or collect cash from the debtors), even low margin which is the difference between the selling price and cost of sales/production.

Selling on credit is not bad in its self but could be a problem if not properly managed. A credit policy must however be well spelt out and strictly adhered to detailing the collection period and action for default. The ability of the business or project to secure credit from its suppliers also goes a long way in reducing the demand for cash outflow and affords the company the opportunity to better plan its cash flow.

·        Investing

This gives an indication of the ability of the business or project to generate sufficient revenue to meet the daily operational needs and how the excess liquidity is being managed or utilized or reinvested in the growth of the business or project. This could be by investing in a new production line, expand market share or invest in money spinning assets with potential for generating future Cash flows (shares, money market products, etc).

·        Financing

This shows the ability of the business or project to meet maturing obligations as they fall due such as debt repayment, borrowings, and payment of dividends to financiers or the ability to generate required funding vide injection of new funds, etc. This is very important to outsiders such as bankers, investors (present or prospective) and measures the financial strategy that the company is employing.

In essence, Cash flow statement, which is also a measure of liquidity, is crucial to the success of any venture and to individuals alike but the crux of the matter is the effective management of the revenue/cash generated. Effective control and monitoring on a regular basis will help determine the variances and correct the deviations early. Cash flow projections are also a useful in planning and budgeting based on historical facts and realistic assumptions as to the future cash flow. This is important for small businesses and serves as a guide and check on spending.

Cash flow Statement is used to determine the short term viability of a company and its ability in settling bills. Cash flow must be positive, sufficient to meet the daily operations, capital expenditure, finance the growth and future cash flows, pay returns to financiers and can stand the test of time. It is worthy of mention that there need to be a balance between profitability measured by the income statement and liquidity measured by the Cash flow statement.

Cash flow planning and management is also important in our individual lives. Several known wealthy people/stars have gone bankrupt because they failed to manage their cash flow effectively, spending more than they earn. Non effective management of cash flow leads to late payment which means reduce profitability, knock on late payment to suppliers, lack of trust/integrity, reduced growth and eventual collapse of the business.

The following questions needs to be answered honestly and effort should be made at making necessary corrections where there is a gap:

·        Are my generating sufficient revenue or cash sales to meet my daily needs?

·        Do I spend more than what I earn? In what areas can I reduce my spending?

·    Do I have a savings culture or do I have any reserve that can be ploughed back into the business in the future?

·        Is my business strong enough to attract investors or secure additional funding?

·        Do I have sufficient liquidity to meet up with maturing obligations as they fall due?

·        Am I disciplined enough to effectively manage my cash flow and cut frivolous spending?

·        Have I been able to separate personal funds from that of the business?

The choice and decision is therefore yours to make. I know you can achieve excellent liquidity once you put your mind to it and make necessary corrections where you fell short.

Please send your mail to Michael@bizadvisory.tk for further information and inquires or request for assistance/advice in developing and managing your Cash flow.