May
20
2019

What Is a Cash Flow Statement and How Can Investors Use It to Their Own Advantage?

The cash flow statement is a statement produced by the public companies on an annual basis in order to identify the inflows and outflows of cash. As opposed to the income statement that identifies the profit for the year, the cash flow statement provides a true picture of the cash in hand of the business. Thus, this statement is useful for understanding the liquidity position of the company. The cash balance presented in the balance sheet is tied with the profit shown in the income statement and therefore the cash statement provides a link between the statement of financial position and statement of comprehensive income.

The cash flow statement identifies various sources of inflow and outflow of cash which are categorized into three major aspects namely operating, financing and investing flows of cash. The operating activities measure the cash that arises as a result of business operations and this starts with the profit after tax as reported in the income statement. Non cash expenses such as depreciation are added back to the PAT whereas accruals of interest and tax expense are adjusted so that the cash outflow is determined.

Changes in the working capital are identified and these are also adjusted accordingly in order to arrive at cash generated from operating activities. The next component of the statement is the investing cash that largely pertain to the capital transactions of the business. Any purchase and sales of property, plant and equipment is recorded in this section in order to identify the net cash from financing activities. Lastly, the financing section highlights the business transactions that are meant to raise finance such as debt issue, equity issue or loan repayment. The financing section highlights the changes in capital structure that came about in a given year. The net result of the cash from operating, investing and financing activities is the cash flow generated during a given year. This is then added with the balance at bank at the year start so that the balance at the year end is computed. This is then verified with the balance shown in the current assets within the balance sheet.

The cash flow statement is of immense importance to the investors as they can identify transactions that are not depicted in the balance sheet and income statement. The company’s cash position determines the liquidity of the firm and the change in cash from year start to the year-end would help the investors in identifying the change in liquidity position. An assessment of the liquidity would enable the investor to identify the ability of the business to pay off its debts with ease.

The cash flow statement can also be used by the investors to identify the free flow of cash within a business. This information is not presented by the income statement that is based on the concept of accruals and prudence. The free flow of cash within a business would help in identifying the true cash that’s generated as a result of the operations after the deduction of any capital expenditure that is required to maintain the operations of the company. Low or negative cash flows would indicate the lack of operating efficiency of the business and therefore investors must analyze the FCF of a given firm over a period of time.

The cash flow statement is also an indicative of the current capital expenditure policy of the firm. The investing section would highlight the expenditure on equipment. A negative or a positive investing cash flow does not indicate the true position of the company. A negative cash flow might arise as a result of high capital expenditure in a given year whereas a positive investing cash flow could come about as a result of sale of equipment. These are one off items and must not be used as a means to assess the liquidity position of a company. An investor can therefore identify the underlying reasons for negative or positive cash flow and therefore ascertain the future stream of cash flows. For example, a large outflow in the present year might result in low or negative cash balance but it is likely to result in more efficient operations which would enhance profitability and thus earning per shares. The investor can therefore use this information to predict the future profitability and operating capacity of the organization.

Furthermore, the finance section depicts the financing activities of the business and allows the investor to ascertain the changes made within the capital structure in a given year. For example, an investor can analyze the increase in debt or equity in a given year and therefore ascertain the changes in financial risk that a firm faces. An investor would also be able to determine the true reason for the cash in hand. For example a low cash balance might indicate low liquidity at a glance. But in reality it might be as a result of debt repayment which is a one off item and therefore the investor would easily be able to conclude that the business at present does not face a shortage of cash due to inefficient operations but simply because of repayment of debt.

An investor is thus able to analyze the various inflows and outflows of cash from the cash flow statement and also ascertain the sources of cash. Investors are able to identify the free cash flows generated from operations and therefore are able to analyze the ability of the business to pay back its debt while also meet its interest payments. The growth prospects and the ability to pay out dividends can also be predicted from FCF. The investor is able to analyze the investment policy of the company for example a firm is likely to pursue an aggressive investment strategy if there are capital outflows over a period of time. Thus, the cash flow statement is of immense importance to the investors who can use it to ascertain the various sources of cash inflow and outflow.

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May
13
2019

Personal Finance Series: No 7 – The Seven Secrets of Switching in Shelter Provision

When considering personal finance budgets, most people will only consider making cutbacks when the money begins to run out, and only then will they think about creating a home budget worksheet, or a personal finance worksheet. The more proactive will have done this well before they get that far, some will even investigate personal finance online, and a proportion of those who do will find that their search leads them to some personal finance online software.

This behaviour though, is in itself not a financial planning definition, and there are seven things that people just don’t think about when completing a personal finance spreadsheet.

1. Shelter Provision – Why People Don’t Switch

Switching means to change service provider either because the service being received is no longer satisfactory, or because it can save money. Yet despite these obvious benefits of better service and financial savings, most people don’t switch.They don’t switch bank accounts because they believe there is a disadvantage to moving from ‘people who know me’. They don’t switch utility providers because they think it’s ‘too much hassle’. The REAL reason why people don’t switch though is apathy. Most people just can’t be bothered.

2. Shelter Provision – Overcoming Apathy

There is a psychological effect known as “bystander behaviour” when people in crowds fail to take any action when they witness a crime or accident together- each believing another will be the one to act. People don’t want to overreact or be embarrassed.

Other studies on apathy showed that people experience apathy when things just don’t affect them, they have a visible lack of emotion or drive. The second secret of switching is to understand that overcoming apathy is easy and possible, and that holding back is damaging the personal finance statement!

3. Shelter Provision – Motivation

Often, Apathy and it’s cousin, procrastination, come from a lack of motivation, which simply means that people either don’t have any goals, or don’t have the right goals.

People in this situation have simply forgotten what they want, their activities just don’t fill them with enough enthusiasm- and this can be traced right back to the lack of goals setting with students, or goals setting templates taught to us at an early age.

Financial goal setting is a powerful way to overcome this apathy – and switching is an instant way to achieve quick savings within a personal finance budget.

4. Shelter Provision – Budget Target

Budgeting can be one of those things that people put off, because it doesn’t necessarily bring pleasure. Yet the whole point of a goal is to connect you to something you want. Saving money releases funds to do exactly that. Often, it is possible to save hundreds just from switching – so set a target from all the possible routine and regular outgoings.

5. Shelter Provision – Prioritise the Prize

It makes sense that one you look at your family budget worksheet, you target the biggest spend items first, and shop around to switch. Some won’t be possible until contracted dates, such as mobile phones or special utility deals, but if you start with the largest first, and then work down the list, you will understand the value of the biggest prize for the least effort.

6. Shelter Provision – The Power They Have

Most service providers are big companies who don’t really know you at all. We think their power is the ability to restrict services – that the bank won’t lend us the money we need because we only just joined them.

We pay Utility bills quickly or on time because they have whole departments of people dedicated to chasing us for money when we don’t and in extreme circumstances we have all heard the tragic stories about people dying because they lost electricity, gas, or water supplies.

We think that they have more power than they actually have. We think that because they are so huge and powerful, that they have all the power – that we have no individual significance to them.

7. Shelter Provision – The Power You Have

Actually, you have much more power than you think. The competition among mobile phone providers, power companies, and in fact every supplier to your home is a very good thing for personal finance budgets.

These organisations now have customer retention departments who try their best to keep you. Savvy customers are very valuable and customer retention departments will offer all sorts of ‘deals’ to keep your business because of the lifetime value of your custom, and the high costs to them of replacing you with someone else. You actually hold ALL the power, because you get to choose who gets your custom.

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