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KR editions 147 to 150

KR-147 : Intro to cash

Hi everyone,

Continuing into the cash flow statement.....

  • The cash flow statement was added later to the list of financial statements produced by companies for their public financial reports.

  • This statement differs from the income statement because it removes away all non-cash items. Some that we've encountered are: deprecation, amortization, unearned revenue, unpaid accounts. 

  • The cash flow statement considers only the cash inflows and outflows in a particular period- thus it gives a better idea of how much cash the company has generated over the last period.

  • Why would the income statement earnings differ from the cash inflow?

  • Because in the income statement we account for revenue once a transaction is considered as completed (even if the cash hasn't come into our account)- for example the customer might have a period of 30 days in which to make the payment. 

  • This is considered as revenue in the income statement but will have to be subtracted out from the cash flow statement (since we haven't yet collected cash as yet). 

  • Cash flow in a business is very important for operations to continue smoothly; a company might report huge profits but might not have that much cash in hand. Generally it is believed that manipulating the cash flow statement is hard! 

  • If you take a look at the cash flow statement you'll find 3 main sections: 
    Cash flows from-
    a.) Operating activities
    b.) Investing activities
    c.) Financing activities

Note: Negative numbers denote cash flowing out and they are usually represented within parentheses (the minus sign is not used).

Did you know that Steve Jobs founded Pixar Animations when he was fired as CEO of Apple Computers? 

KR-148 : Why bother of cash flow?

We had an intro into the cash flow statement in the previous edition...but before analyzing this further one needs to appreciate the importance of cash flow in an organization.

Let's take a simple example- 

  • Our whizkid got the idea of creating personalized greeting cards using chart paper and paints. He already has a paintbox and he can do the work on his own. He only needs to buy chart paper. 

  • One chart paper costs Rs.5 and our whizkid estimates, "I can make 4 greeting cards from 1 chart paper. Each greeting card I can sell for Rs.10 and so I can earn Rs.40 for the Rs.5 that I spend". 

  • But he doesn't have Rs.5 with him and so he borrows this from his friend (as a loan which he'll repay back).

  • He borrows the money on 1st nov, buys the chart paper and starts designing the cards. 

  • By 25 Nov. he's done with all 4 cards and sells them within 5 days. But his customers (who are his relatives) tell him that they'll pay him the money after a few days. They are known people and so our whizkid can't refuse and he agrees. He knows that they'll mostly pay him back.

  • So now what does our whizkid do? He realizes that there is potential to make more money and wants to make more greeting cards. But he needs to buy more chart paper for that and for this he needs money (curretly he has nothing). 

  • At this juncture our whizkid has a cash flow problem. He doesn't have money to spend or expand!

  • One option is to try and borrow money from someone else but this again leads to more debt.

  • But remember that he is already in debt of Rs.5 and his friend is bound to keep asking him for the money (even if it were his dearest friend).

From a financial view point:

  • Dearest friend is a creditor.

  • The 4 customers who bought the cards haven't paid money and so this Rs. 40 will be accounted for under "accounts receivable". 

  • On the income statement Rs.40 is recorded as an income but in reality this money hasn't yet come in. 

  • So if one went by the P&L statement they would think whizkid is doing great (he spent Rs.5 and earned Rs.40) but in reality whizkid is in trouble; no money to spend and has debt as well.

Did you know that by analyzing the cash flow statements investors can avoid potential pitfalls? We'll explore further in future editions.

KR-149 : More Cash

A short KR with some more info on cash...

The Cash flow cycle:

In an organization cash flow would be somewhat as described below:

  • Cash has to be initially spent in setting up the business. 

  • Cash has to be spent in purchasing assets: equipment and in employing labor. 

  • To support the expenses the organization would borrow money - i.e. using creditor's cash. 

  • Production would begin. 

  • Once products have been developed they have to be sold (sales). 

  • But even at the point of sales the company doesn't get cash. 

  • After sales we have a stage called "collection" where cash actually flows into the business. 

  • At the point of sales the company will record the transaction and this would get reported on the income statement but money need not have been received by the company. 

  • There have been cases where a company shows a strong income statement but had to close down because they had cash flow problem. 

  • There are different types of transactions based on their effects on cash and profits: 

  1. Transactions that increase profit but produce no cash now.

  2. Reduce profit but no impact on cash now.

  3. Increase cash but don't affect profit now.

  4. Decrease cash but don't affect profit now. 

Can you think of examples for these four types of transactions?

Did you know that by analyzing the cash flow statements of a company investors can predict to some extent whether a company will wind up soon or not?

KR-150 : Cash - 4 TRX

Hurray!!! KR touches the 150 editions milestone today!  Hope the previous editions were informative...suggestions, contributions, techie tips etc. are welcome from all...

We left off the last KR examining the different types of transactions based on how they impact cash and profit. The four are:

  • Transactions that increase profit but produce no cash till a later date.

Simple example is accounts receivable. Customer doesn't pay back instantly but the company records this as a profit (since a product has been sold). Cash will flow in but only at a later date. So profit up, cash neutral.

  • Transactions that decrease profit but don't affect cash till a later date.

This is the reverse of case 1. Example: Accounts payable. Here the company might have bought a product for which they haven't paid back immediately. So the transaction is recorded as a loss for the company but cash hasn't changed hands. So profit down, cash neutral.

  • Transactions that increase cash but don't affect profit now.

Example: A loan borrowed from a bank or outsiders investing in the company. This is not indicated in the income (P&L) statement. But the money will appear on the balance sheet. So cash increases but no profit.

  • Transactions that decrease cash but don't affect profit now.

Example: repayment of a loan. This isn't shown in the income statement but the company is actually giving out cash back to the creditors. So cash keeps dropping while profit still remains unaffected.

Can you think of other examples for the above transactions? Which category do you think deprecation falls unders?

Next up a look at the cash flow statement. There are 2 forms of reporting used- direct and indirect.

More on that in the next edition...
(we shall take a break from management and go back into some techie editions after covering the cash flow statement).

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