CASH FLOW

Cash flow analysis is a method of analyzing the financing, investing, and operating activities
of a company. The primary goal of cash flow analysis is to identify, in a timely manner, cash
flow problems as well as cash flow opportunities. The primary document used in cash flow
analysis is the cash flow statement. Since 1988, the Securities and Exchange Commission
(SEC) has required every company that files reports to include a cash flow statement with
its quarterly and annual reports. The cash flow statement is useful to managers, lenders,
and investors because it translates the earnings reported on the income statement—which
are subject to reporting regulations and accounting decisions—into a simple summary of
how much cash the company has generated during the period in question. "Cash flow
measures real money flowing into, or out of, a company's bank account," Harry Domash
notes on his Web site, WinningInvesting.com. "Unlike reported earnings, there is little a
company can do to overstate its bank balance."
THE CASH FLOW STATEMENT

A typical cash flow statement is divided into three parts: cash from operations (from daily
business activities like collecting payments from customers or making payments to suppliers
and employees); cash from investment activities (the purchase or sale of assets); and cash
from financing activities (the issuing of stock or borrowing of funds). The final total shows
the net increase or decrease in cash for the period.

Cash flow statements facilitate decision making by providing a basis for judgments
concerning the profitability, financial condition, and financial management of a company.
While historical cash flow statements facilitate the systematic evaluation of past cash flows,
projected (or pro forma) cash flow statements provide insights regarding future cash flows.
Projected cash flow statements are typically developed using historical cash flow data
modified for anticipated changes in price, volume, interest rates, and so on.

To enhance evaluation, a properly-prepared cash flow statement distinguishes between

recurring and nonrecurring cash flows. For example, collection of cash from customers is a
recurring activity in the normal course of operations, whereas collections of cash proceeds
from secured bank loans (or issuances of stock, or transfers of personal assets to the
company) is typically not considered a recurring activity. Similarly, cash payments to
vendors is a recurring activity, whereas repayments of secured bank loans (or the purchase
of certain investments or capital assets) is typically not considered a recurring activity in the
normal course of operations.
In contrast to nonrecurring cash inflows or outflows, most recurring cash inflows or outflows
occur (often frequently) within each cash cycle (i.e., within the average time horizon of the
cash cycle). The cash cycle (also known as the operating cycle or the earnings cycle) is the
series of transactions or economic events in a given company whereby:
1. Cash is converted into goods and services.
2. Goods and services are sold to customers.
3. Cash is collected from customers.

To a large degree, the volatility of the individual cash inflows and outflows within the cash
cycle will dictate the working-capital requirements of a company. Working capital generally
refers to the average level of unrestricted cash required by a company to ensure that all
stakeholders are paid on a timely basis. In most cases, working capital can be monitored
through the use of a cash budget.
THE CASH BUDGET

In contrast to cash flow statements, cash budgets provide much more timely information
regarding cash inflows and outflows. For example, whereas cash flow statements are often
prepared on a monthly, quarterly, or annual basis, cash budgets are often prepared on a
daily, weekly, or monthly basis. Thus, cash budgets may be said to be prepared on a
continuous rolling basis (e.g., are updated every month for the next twelve months).
Additionally, cash budgets provide much more detailed information than cash flow
statements. For example, cash budgets will typically distinguish between cash collections
from credit customers and cash collections from cash customers.

A thorough understanding of company operations is necessary to reasonably assure that the

nature and timing of cash inflows and outflows is properly reflected in the cash budget.
Such an understanding becomes increasingly important as the precision of the cash budget
increases. For example, a 360-day rolling budget requires a greater knowledge of a
company than a two-month rolling budget.

While cash budgets are primarily concerned with operational issues, there may be strategic
issues that need to be considered before preparing the cash budget. For example,
predetermined cash amounts may be earmarked for the acquisition of certain investments
or capital assets, or for the liquidation of certain indebtedness. Further, there may be policy
issues that need to be considered prior to preparing a cash budget. For example, should
excess cash, if any, be invested in certificates of deposit or in some form of short-term
marketable securities (e.g., commercial paper or U.S. Treasury bills)?
Generally speaking, the cash budget is grounded in the overall projected cash requirements
of a company for a given period. In turn, the overall projected cash requirements are
grounded in the overall projected free cash flow. Free cash flow is defined as net cash flow
from operations less the following three items:
1. Cash used by essential investing activities (e.g., replacements of critical capital
assets).
2. Scheduled repayments of debt.
3. Normal dividend payments.

If the calculated amount of free cash flow is positive, this amount represents the cash
available to invest in new lines of business, retire additional debt, and/or increase dividends.
If the calculated amount of free cash flow is negative, this amount represents the amount of
cash that must be borrowed (and/or obtained through sales of nonessential assets, etc.) in
order to support the strategic goals of the company. To a large degree, the free cash flow
paradigm parallels the cash flow statement.

Using the overall projected cash flow requirements of a company (in conjunction with the
free cash flow paradigm), detailed budgets are developed for the selected time interval
within the overall time horizon of the budget (i.e., the annual budget could be developed on
a daily, weekly, or monthly basis). Typically, the complexity of the company's operations
will dictate the level of detail required for the cash budget. Similarly, the complexity of the
corporate operations will drive the number of assumptions and estimation algorithms
required to properly prepare a budget (e.g., credit customers are assumed to remit cash as
follows: 50 percent in the month of sale; 30 percent in the month after sale; and so on).
Several basic concepts germane to all cash budgets are:
1. Current period beginning cash balances plus current period cash inflows less current
period cash outflows equals current period ending cash balances.
2. The current period ending cash balance equals the new (or next) period's beginning
cash balance.
3. The current period ending cash balance signals either a cash flow opportunity (e.g.,
possible investment of idle cash) or a cash flow problem (e.g., the need to borrow
cash or adjust one or more of the cash budget items giving rise to the borrow
signal).
RATIO ANALYSIS

In addition to cash flow statements and cash budgets, ratio analysis can also be employed
as an effective cash flow analysis technique. Ratios often provide insights regarding the
relationship of two numbers (e.g., net cash provided from operations versus capital
expenditures) that would not be readily apparent from the mere inspection of the individual
numerator or denominator. Additionally, ratios facilitate comparisons with similar ratios of
prior years of the same company (i.e., intracompany comparisons) as well as comparisons
of other companies (i.e., intercompany or industry comparisons). While ratio analysis may
be used in conjunction with the cash flow statement and/or the cash budget, ratio analysis
is often used as a stand-alone, attention-directing, or monitoring technique.
ADDITIONAL BENEFITS

In his book, Buy Low, Sell High, Collect Early, and Pay Late: The Manager's Guide to
Financial Survival, Dick Levin suggests the following benefits that stem from cash
forecasting (i.e., preparing a projected cash flow statement or cash budget):
1. Knowing what the cash position of the company is and what it is likely to be avoids
embarrassment. For example, it helps avoid having to lie that the check is in the
mail.
2. A firm that understands its cash position can borrow exactly what it needs and no
more, there by minimizing interest or, if applicable, the firm can invest its idle cash.
3. Walking into the bank with a cash flow analysis impresses loan officers.
4. Cash flow analyses deter surprises by enabling proactive cash flow strategies.
5. Cash flow analysis ensures that a company does not have to bounce a check before
it realizes that it needs to borrow money to cover expenses. In contrast, if the cash
flow analysis indicates that a loan will be needed several months from now, the firm
can turn down the first two offers of terms and have time for further negotiations.
LOAN APPLICATIONS

Potential borrowers should be prepared to answer the following questions when applying for
loans:
1. How much cash is needed?
2. How will this cash help the business (i.e., how does the loan help the business
accomplish its business objectives as documented in the business plan)?
3. How will the company pay back the cash?
4. How will the company pay back the cash if the company goes bankrupt?
5. How much do the major stakeholders have invested in the company?

Admittedly, it is in the best interest of the potential borrower to address these questions
prior to requesting a loan. Accordingly, in addition to having a well-prepared cash flow
analysis, the potential borrower should prepare a separate document addressing the
following information:
 1. Details of the assumptions underpinning the specific amount needed should be
prepared (with cross-references to relevant information included in the cash flow
analysis).
2. The logic underlying the business need for the amount of cash requested should be
clearly stated (and cross-referenced to the relevant objectives stated in the business
plan or some other strategic planning document).
3. The company should clearly state what potential assets would be available to satisfy
the claims of the lender in case of default (i.e., the company should indicate the
assets available for the collateralization of the loan).
4. Details of the equity interests of major stakeholders should be stated.

In some cases, the lender may also request personal guarantees of loan repayment. If this
is necessary, the document will need to include relevant information regarding the personal
assets of the major stakeholders available to satisfy the claims of the lender in case of
default.
INADEQUATE CAPITALIZATION

Many businesses fail due to inadequate capitalization. Inadequate capitalization basically

implies that there were not enough cash and/or credit arrangements secured prior to
initiating operations to ensure that the company could pay its debts during the early stages
of operations (when cash inflows are nominal, if any, and cash outflows are very high).
Admittedly, it is extremely difficult to perform a cash flow analysis when the company does
not have a cash flow history. Accordingly, alternative sources of information should be
obtained from trade journals, government agencies, and potential lenders. Additional
information can be solicited from potential customers, vendors, and competitors, allowing
the firm to learn from others's mistakes and successes.
UNCONSTRAINED GROWTH

While inadequate capitalization represents a front-end problem, unconstrained growth

represents a potential back-end problem. Often, unconstrained growth provokes business
failure because the company is growing faster than their cash flow. While many cash flow
problems are operational in nature, unconstrained growth is a symptom of a much larger
strategic problem. Accordingly, even to the extent that cash flow analyses are performed on
a timely basis, such analyses will never overcome a flawed strategy underpinning the
unconstrained growth.
BANKRUPTCY

A company is said to be bankrupt when it experiences financial distress to the extent that
the protection of the bankruptcy laws is employed for the orderly disposition of assets and
settlement of creditors's claims. Significantly, not all bankruptcies are fatal. In some
circumstances, creditors may allow the bankrupt company to reorganize its financial affairs,
allowing the company to continue or reopen. Such a reorganization might include relieving
the company from further liability on the unsatisfied portion of the company's obligations.
Admittedly, such reorganizations are performed in vain if the reasons underlying the
financial distress have not been properly resolved. Unfortunately, properly-prepared and
timely cash flow analyses can not compensate for poor management, poor products, or
weak internal controls.
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Cash Flow

Change Company Go
Hindustan Organic Chemicals Ltd. 32.65 (-0.46%)

BSE Code 500449 NSE Code HOCL P/E 31.84

ISIN Demat INE048A01011 Dividend Yield % 0.00 EPS 1.03
Book Value -27.10 Market Cap 2206.64 Face Value 10

(Rs. in Million)
Particulars Mar 2010 Mar 2009 Mar 2008 Mar 2007 Mar 2006
Profit Before Tax -843.20 -257.35 139.94 176.87 -564.81
Adjustment 505.09 491.29 407.05 470.33 570.26
Changes In working Capital 124.11 -505.70 -197.50 -2.96 82.70
Cash Flow after changes in Working Capital -214.00 -271.75 349.49 644.25 88.15
Cash Flow from Operating Activities -214.00 -275.70 350.73 593.30 121.21
Cash Flow from Investing Activities 31.47 -170.00 -108.61 -30.07 -12.05
Cash Flow from Financing Activities 7.88 281.15 -524.13 288.69 -129.71
Net Cash Inflow / Outflow -174.65 -164.56 -282.01 851.92 -20.54
Opening Cash & Cash Equivalents 464.14 628.69 910.71 58.79 79.33
Cash & Cash Equivalent on Amalgamation / Take
0 0 0 0 0
over / Merger
Cash & Cash Equivalent of Subsidiaries under
0 0 0 0 0
liquidations
Translation adjustment on reserves / op cash
0 0 0 0 0
balalces frgn subsidiaries
Effect of Foreign Exchange Fluctuations 0 0 0 0 0
Closing Cash & Cash Equivalent 289.48 464.14 628.69 910.71 58.79

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The Cash Flow Statement - Part II

As you know, when a balance sheet shows aggregate Assets greater than or less than Total Liabilities plus Equity, it
is easy to conclude that something went wrong in the preparation of the financial accounts, as a correctly completed
balance sheet should always show total assets equaled to total liabilities plus equity.

Another simple test of the accuracy of the financial accounts is the cash flow statement, because if a completed cash
flow statement shows changes in cash which when added to the opening cash balance (cash balance on the prior
period balance sheet) does not add back to the closing cash balance (cash balance on this period's balance sheet),
then it is clear that something went wrong when the Cash Flow Statement was prepared.
After completing your cash flow statement, you should close it by ensuring that the cash balance reconciles back to
the cash balance on the balance sheet.
There are two main method of preparation for the cash flow statement. The Indirect method is the more common of
the two, but the Direct method has been gaining exposure over the years. In the example shown above (part 1), the
cash flow statement was prepared using the Indirect method, and as you can see the approach used is to reconcile
net income to cash.
The need for a cash flow statement arise from the fact that financial accounts is prepared on what is known as the
accrual basis, matching expenses to revenue in the period in which they are incurred and not when they're paid. This
accrual basis accounting process leads to the calculation of net income (revenue less expenses), which bears no
relationship to the actual flow of cash.
 In adjusting the accrual-based financials, the cash flow statement seeks first to adjust net income and then to
calculate cash flow from investing and financing activities. Net income is adjusted in the Cash Flow from Operations
section of the cash flow, adding back to net income all non-cash charges and subtracting all non-cash income.
Examples of non-cash charges are shown below:

• Depreciation

• Bad Debts

• Provisions

• Accrued charges
Examples of non-cash income are shown below:

• Accounting gains (e.g. gain on sale of fixed assets)

• Equity in earnings of affiliated companies

• Deferred income taxes

The company's net income/loss is the first item on the cash flow statement. The non-cash charges listed above,
along with other non-cash charges are added to the income statement (as shown below):

Net Income/(Loss) $100,000

Add non-cash charges:
Plus depreciation $5,000
Bad Debt write-off $2,000
Less non-cash gains:
Gain on sale of business $10,000
Equity - earnings of affiliates
$1,000
Adjusted Net Income $96,000
"Adjusted net income" as shown above is sometimes referred to as Funds Flow and represents the adjusted net
income on the Cash Flow Statement before the effects of changes in working capital is factored in. Assessing and
applying changes in working capital is the necessary final step to completely convert accrual base net income to cash
base net income.
The main working capital items are Accounts Receivable, Inventory and Trade Payable. These are not the only
working capital items, but they are the main ones, and the next balance sheet you review will quite likely have these
three items listed among a few others.
Why would the change in a working capital item, Accounts Receivable for instance, be relevant to the determination
of cash based net income? Relevancy comes from knowing what is Accounts Receivable, and where it comes from.
Accounts receivable is the unpaid (customers have not yet paid their invoices) portion of the company's revenue, and
should therefore beremoved from net income to determine cash-base net income. The example below should add
some clarity:

The Cash Flow Statement - Part III

An example
This is company A's first year in business. The company ended the year with revenue of $200,000. Of this amount,
payment was received for only $35,000. The balance of $165,000 is shown on the balance sheet as Accounts
Receivable.

The company incurred expenses of $120,000 during the year. Of the total expenses, the following is true:
• Non-cash charges - Depreciation $15,000

• Expenses on which credit was received - $105,000

Company A's calculated net income is shown below:

Total Revenue $200,000

Less expenses $120,000
Net Income $80,000
Of the $80,000 in net income, Company A has only $35,000 in cash. Why is that? This may be illustrated using the
cash flow statement. The statement below is based on the information we have about Company A's trading activities:
COMPANY A
STATEMENTS OF CASH FLOWS (Abridged)

Net Income $80,000

Add back non-cash charges $15,000
Funds Flow $95,000
Changes in working capital
Increase in Accts Receivable -$165,000
Increase in Accts Payable $105,000
Cash inflow to company A $35,000

The example above provides a simple introduction to preparing the cash flow statement. There are a few things to
note before you go on:

• The actual excess of revenue over cost is $105,000, which is total expenses ($120,000) less depreciation

($15,000).

• The increase in Accounts Receivable is deducted from Funds Flow

• The increase in Accounts Payable is added to Funds Flow

Accounts Receivable and Accounts Payable, as well as all other working capital items are included in the cash flow
statement because they are important to the flow of cash in and out of the business. The general rule when including
changes in working capital to the cash flow statement is shown below:

• Increase in assets - Outflow/Use of funds

• Increase in liabilities - Inflow/Source of funds

• Decrease in assets - Inflow/Source of funds

• Decrease in liabilities - Outflow/Use of funds

In our example, we assumed that Accounts Receivable was zero at the beginning of the accounting period and
$165,000 at the end. That's a $165,000 increase in A/R which is then included on the cash flow statement as a Use
of fund (subtracted from income).

Similarly, our assumption regarding Accounts Payable was that A/P was zero at the beginning of the year and
$105,000 at the end. The increase in A/P is then included on the cash flow statement as a Source of fund (added to
net income).
Finally, to see how we moved from a revenue position of $200,000 to cash in hand of $35,000, we will follow the
money trail:
• Company A purchased $105,000 in inventory. How did it pay for this and still end up with $35,000 in cash? The

answer is that Company A has not paid for the inventory. This $105,000 is still owed to suppliers. This is shown

as the increase in Accounts Payable in the Cash Flow Statement.

• Of the $200,000 in revenue, Company A's customers are holding onto $165,000. This is shown on the Cash

Flow Statement as the increase in Accounts Receivable. The full amount of cash collected from customers is

$35,000 and this is the only cash that Company A has, and this is what is shown on the Cash Flow Statement

as Cash Inflow (see above).

That's it for the section of the Cash Flow Statement covering Cash Flow from Operations. As you may have
recognized, this section of the Cash Flow Statement is very important to the investors, creditors and management
due mainly to the fact that it shows just how liquidity generating is the company through its operation.

The Cash Flow from Investing and Financing sections

The remaining portion of the Cash Flow Statement is divided between the Investing and Financing sections. These
sections are not as academically demanding as the Cash Flow from Operating section, but they are very important to
a full understanding of the company's cash inflow and outflow.
"Investing activities" as used in the Cash Flow Statement refers to the investments made by management and
includes both losses and gains from those investments. This section displays:

• Cash flows from acquiring and disposing short-term investments other than cash equivalents.

• Cash flows from acquiring and disposing fixed assets.

Cash flow from investing activities refers to the cash inflow and outflow related to external financing. The section
displays cash flows from obtaining financing from and making payments to shareholders and creditors. The line items
in this section may be the following:

• Cash flow related to new issue of stock (common or preferred)

• Loan proceeds or payments

• Dividends payments as well.

While the Cash Flow from Operations section of the Cash Flow Statement is arguably the most significant section
from an analytical perspective, the other two sections should not be ignored or belittled.

Free Cash Flow:

Free Cash Flow is a performance indicator that has taken on significance in recent time. The company's Free Cash
Flow is calculated by taking Total Capital Expenditure from Cash Flow from Operations:
Cash Flow from Operations - Capital Expenditure

Capital Expenditure (investment in plant, equipment, property and other similar assets) is usually the first item listed
in the Cash Flow from Investing activities section of the Cash Flow Statement, making Free Cash Flow calculation
easy to accomplish while reviewing the Cash Flow Statement.
Free Cash Flow has gained the attention of investors and analysis because it reflects the cash available to the
company for "free" or discretionary spending. Capital expenditure is required spending by the company to
maintain/improve its present stock of assets in a competitive environment and a company's ability to generate cash in
excess of this amount is considered bonus.
Free Cash Flow gives a company the cash resources to do things such as pay dividends, pay down debts, purchase
new businesses etc., so the next time you review the Cash Flow Statement, take a few minutes to analyze free cash
flow; it could be the difference between a good decision and a very good decision!