CASH FLOW MANAGEMENT A cash flow statement is one of the general purpose financial statements required to be prepared for

all stakeholders as provided in the Philippine Accounting Standards 1 (Presentation of Financial Statements). General purposes financial statements are informative reports designed to assist users in making sound economic decision. (PAS 1 par. 3 and 8) OBJECTIVES It is managements responsibility to maintain a proper balance between the cash collections and the cash disbursements and ensure that only a sufficient amount of cash is kept on hand by the firm. Too little cash or too much cash will affect the smooth flow of financial operation. And it is for lack of proper cash management that some businesses fail.
A few questions asked that can be answered only by this statement are: How is cash obtained by the business? How does business spend its cash? What caused the change in the cash? Why is there a large net income but cash is down? Is cash sufficient to pay the obligations on time? Can dividends be regularly distributed to shareholders? USES The cash flow statement will provide the answers to these questions and enlighten us on how cash is being managed by the firm. The Cash Flow Statement when used with the other general purpose financial statements will benefit users and enable them to: 1) assess the firms ability to generate cash in the future and predict future cash flows evaluate the firms financial position as to liquidity and solvency examine the relationship between the net income (which normally is under the accrual basis) and the cash flow from operation evaluate changes in the entitys net assets (assets less liabilities) evaluate entitys ability to adopt to pressures and changing circumstances and opportunities assist management in their planning and controlling

2) 3) 4) 5) 6)

functions CONCEPT OF CASH

The concept of cash as provided in PAS 7.6 covers not only cash but also cash equivalents. Cash includes cash on hand and demand deposits. Cash equivalents include treasury and commercial bills, short-term highly liquid investments such as time deposits readily convertible into cash within three months from acquisition date.

MAJOR CATEGORIES OF CASH ACTIVITIES

The change in the cash position is brought about by three kinds of activities: operating, investing and financing. Operating Activities. These are the principal income producing activities represented by revenues from sale of goods or services; receipts for royalties, fees, commissions and other revenues; payments to suppliers for goods and services (expenses); payments to employees; payment to government; payment to others for contract services. (PAS 7.14) Investing Activities. These are represented by the acquisition and disposal of non-current assets such as plant, property and equipment; payments and receipts from acquisition and sales of long term investments such as bonds and securities or interest in joint ventures; receivables or cash advances/loans of officers and employees and other parties. (PAS 7.16) Financing Activities. These are represented by the debt borrowings and repayments of loans made by the enterprise; contributions and withdrawals (dividends) of investors or equity participants. (PAS 7. 17) A business should be able to generate sufficient cash from operating activities so that obligations may be paid including extinguishments of loans and cash withdrawals or dividends distribution to investors. It is good for the business to generate more cash from operating activities rather than from the financing and investing activities. Revenues should easily be converted into cash so that disbursements could easily be paid. For short run planning, management strictly monitors cash to ensure that there is no cash shortage nor overage. This can be done with the right balance by planning how and when cash will be obtained and used. Aside from management, other interested parties in the cash flow statement are the investors, creditors and suppliers. Cash flow is either an inflow (source or receipt) or outflow (use or payment). The table shows different activities and its effect on cash : Operating Cash Inflow from Sale of goods or services; Interest on loans granted Cash Outflow to/for Suppliers for purchase of goods; Employees for salaries; Government for taxes; Lenders for interest; Utility companies for utilities; Others for advertising, delivery, etc Cash Outflows Purchase of land, building, furniture, machinery and equipment; Purchase of securities such as bonds and stocks acquired from other companies; Officers, employees and

Investing

Cash Inflows Sale of land, building, furniture, machinery and equipment; Sale of securities such as bonds and stocks acquired from other companies; Collection of principal of

loans, and advances Financing Cash Inflows Borrowings; Investors contributions

outsiders for loans and advances Cash Outflows Payments for amounts borrowed; Owners withdrawal; Dividends

REPORTING CASH FLOW FROM OPERATING ACTIVITIES

There are two methods of reporting cash flow from operating activities: direct method and indirect method. Under the direct method major classes of cash receipts and cash payments are presented in the statement to arrive at the cash flow from operating activities. The major activities may be classified into three: a) b) c) collections from clients and customers payments to suppliers payments for expenses

Under the indirect method, the major classes of receipts and payments are not presented. The procedure is to convert the net income from the accrual basis to cash basis through a series of adjustments for the effects of non-cash transactions such as the increases or decreases in receivables, payables, prepayments and deferments of income and expenses.

ANALYZING THE CASH FLOW STATEMENT

Liquidity Aside from the liquidity ratios mentioned in Chapter 11, another ratio which can be used to evaluate the entitys liquidity is the Current Cash Debt Coverage Ratio. The formula is Cash from Operating Activities / Average Current Liabilities. It is considered a better measurement of liquidity since it is more realistic as it uses cash from operation to settle obligations. Solvency Aside from the debt ratio, equity ratio and interest earned ratio another ratio that is used to measure solvency is the Cash Debt Coverage Ratio. The formula is Cash from Operating Activities/ Average Total Liabilities Free Cash Flow This measures the ability of the cash from operating activities to fund expansion (acquisition of properties) and payment of dividends. The formula is: Free Cash Flow= Cash from Operating Activities less Payment for Dividends and Acquisition of Equipment

Free cash flow gives the company much leeway as this extra cash may be used for unexpected/emergency disbursements of the company. Cash Flow to Net Income This shows the relationship of the cash to the net income earned by the entity. Or stated in another way, this shows the cash generated by a peso of sale.

CASH FLOW PROBLEM 1 A comparative balance sheet for the Visor Corporation is presented below: VISOR CORPORATION Comparative Balance Sheet (thousands omitted) 2010 Assets Cash Accounts receivable (net of allow of P25,000/P20,000 ) Prepaid insurance Land Equipment Accumulated depreciation Total Assets $ 40,000 80,000 22,000 18,000 70,000 (20,000) $210,000 $ 31,000 60,000 17,000 40,000 60,000 (13,000) $195,000 $ 6,000 19,000 115,000 55,000 $195,000 2009

Liabilities and Stockholders' Equity Accounts payable $ 12,000 Bonds payable 27,000 Common stock 140,000 Retained earnings 31,000 Total liabilities and stockholders' equity $210,000

Additional information (THOUSANDS OMITTED): a. Net loss for 2010 is $22,000. Net sales for 2008 are $250,000 with cost of sales of 80% b. Operating expenses $75,000 includes depreciation, bad debts, $600 tax on gain on sale of equipment, loss from sale of land, and interest expense on bonds of P1,200. c. Land was sold for cash at a loss of $10,000. This was the only land transaction during the year. d. Equipment with a cost of $15,000 and accumulated depreciation of $10,000 was sold for $8,000 cash. e. $12,000 of bonds were retired during the year at carrying (book) value. f. Equipment was acquired for common stock. The fair market value of the stock at the time of the exchange was $25,000. Questions (answers with supporting computations) 1. What is the cash flow from operating activities using the indirect method?

2. 3. 4. 5. 6. 7. 8. 9.

What is the cash flow from investing activities? What is the cash flow from financing activities? What non-cash information should be disclosed below the cash flow statement? Is the company liquid and able to pay for its current liabilities using cash from operations? Is the company flexible? Does it have a positive or free cash flow? What is the reason for its net positive (negative) cash flow? Using the ratios you have computed and the cash pattern of the firm, is the CFO efficient in managing the cash of the corporation?

10. Using the direct method, compute for a) collection from customers b) payment to suppliers c) payment for expenses CASH FLOW PROBLEM 2 As you were walking down the hall to your office at Oplan Company, you met the company president. She was disturbed at the latest financial statements and wanted your help. She explained that the company was faced with a serious shortage of cash even though profits were high and working capital increased. She showed you the following condensed financial statements. (All data are in thousands). Oplan Company, Income Statement for 2010 Sales P 6,720 Cost of sales Gross profit Operating expenses and other losses Net income 3,850 P 2,870 2,140 P 730

Oplan Company, Statement of Financial Position, as of Dec 31 Assets 2010 2009 Change Cash P 575 P 380 P 195 Accounts receivable, net 990 860 130 Inventory 1,445 1,200 245 Plant and equipment, net 4,050 3,370 68 0 Investments 1,200 1,800 (600) Totals P 8,260 P 7,610 Liabiities & Shareholders Equity Accounts Payable P 190 280 (90) Accrued Expenses 110 200 (90) Long-term debt 2,250 2,200 50 Common stock 2,280 2,080 200 Retained earnings 3,430 2,850 580 Totals P 8,260 P 7,610 The president told you that it had been touch-and-go whether the company would have enough cash to pay a P200,000 dividend that she wants to distribute Dec 31, 2011. The directors expect to realize excellent yields based on the previous company performance. To be able to pay the current dividends, the company had to increase its long term borrowings by P50,000. We made P730,000 but had depreciation expense of P150,000,

1.

2. 3. 4. 5. 6.

bad debts written off of P20,000 and a loss from sales of investments of P50,000. We did buy P830,000 worth of plant assets but covered this up with the sale of some investments while P200,000 of the acquisition was in exchange for common shares. Look at this stuff and tell me what happened to the cash and to the working capital?. Required: Explain the results by preparing the cash flow statement showing the net cash flows from operating activities ( using the indirect method), financing activities and investing activities. Disclose the non-cash information below the cash flow statement Compute for the adequacy ratios to meet company obligations. Compute for the cash generated by a peso of net income Can operation generate enough cash to pay the desired dividends? Explain to the president why she should not worry (or should she?) about the cash position. Compute for the cash collection from customers, payment to suppliers and payment for expenses using the direct method..