1. Cash Flow Analysis SPACE-IOUS Cars Ltd Mary Low
Waikato Management School
The University of Waikato
© Mary Low
© Mary Low

2. Importance of Cash Remember that in finance*, cash is king.
To explain the importance of cash, let us first look at this hint provided by Gitman (2000) in a Managerial Finance textbook.
Remember that in finance*, cash is king.
Income statement [Performance statement] profits are good, but they do not pay the bills nor do asset owners accept them in place of cash.
* Gitman defines finance as ‘the art and science of managing money’ (p. 2).
 Profits do not represent cash in the business. Income (Performance) Statement profits are determined under GAAPs.
© Mary Low

3. Why is Cash important?
You could say that Cash is one of the most important assets in an organisation
Without cash, an organisation will not survive in the long term.
You might try and think of cash as petrol that you need for your car to go!
You car won’t go if your petrol gauge indicates ‘empty’.
Neither will the business ‘go’ if it doesn’t have cash!
A business without cash cannot:
pay for supplies, wages and other operating costs
buy assets to help it earn revenues,
repay debts or reward its owners
© Mary Low

4. How to evaluate an organisation’s cash flows?
To evaluate an organisation’s cash flows, we usually look at their Statement of Cash Flows
The statement of cash flows summarises how an organisation’s operating, investing and financing activities have affected cash during an accounting period.
Operating activities
Financing activities
Investing activities
© Mary Low

5. Statement of Cash Flows – Operating Activities
This category of activities show cash flows directly related to the production and sale of the organisation’s goods and services.
Net cash flow
from operating
activities
Cash Sales
Accounts Receivables
Cash inflows
from customers
Interest
Tax
Suppliers
Operating Expenses
Cash outflows to
suppliers, employees
and other expenses
© Mary Low

6. Statement of Cash Flows – Investing Activities
This category of activities show cash flows related with the acquiring and selling of non-current assets like property, plant and equipment assets and investments.
Sale of
Property, plant
and equipment assets
Purchase of
investments
Net cash flow
from investing
activities
Sale of investments
Cash
outflow
inflow
© Mary Low

7. Statement of Cash Flows – Financing Activities
This category of activities show cash flows related with equity capital contribution and rewards to owner(s) and debt borrowing and repayments.
Capital contribution/
Issue of shares
Short-term /
long term borrowing
Cash Drawings by sole trader or
dividends paid to shareholders
Repayment of short-term /
Cash
inflow
outflow
Net cash flow
from financing
activities
© Mary Low

8. How to evaluate a Statement of Cash Flows
We will look at SPACE-IOUS Cars Ltd, a fictitious example from 2 situations.
Situation 1 shows an overall favourable cash position for the SPACE-IOUS Cars Ltd business.
Situation 2 – You are to try this as a practice example.
What makes the cash position and cash flows favourable or unfavourable need to be examined.
© Mary Low
© Mary Low

9. Situation 1 - Details Statement of Cash Flows for the year ended
31 March 2005
31 March 2006
Cash flows from Operating Activities
Receipts from customers
$3,381,000
$4,011,000
Payments to suppliers
(1,940,000)
(2,530,000)
Payments for operating expenses
(980,000)
(990,000)
Interest paid
(43,000)
(22,000)
Tax paid
(45,000)
(53,000)
Net cash flow from operating activities
373,000
416,000
Cash flows from Investing Activities
Purchase of non-current assets
(95,000)
(79,000)
Net cash flow from investing activities
Cash flows from Financing Activities
Share issues
32,000
Loan repayment
(80,000)
(30,000)
Net cash flow from financing activities
(48,000)
Net Increase (Decrease) in cash
$230,000
$307,000
Opening cash balance
25,000
255,000
Closing cash balance
$255,000
$662,000
© Mary Low

10. Situation 1 - Analysis
The overall cash position in SPACE-IOUS Cars Ltd (Situation 1) is favourable because of the following reasons:
Net increase in cash in 2005 was $230,000. In 2006, the net increase in cash was $307,000 resulting in an overall cash closing balance of $662,000.
Net cash flow from operating activities is positive. In 2005, it was $373,000 and in 2006 it was $416,000. It is important to have positive operating net cash flows. Positive operating cash flows tells us that we should be able to pay for operating costs, have cash available for purchase of assets and investments as well as repay borrowings and rewarding the owner(s).
© Mary Low

11. Situation 1 – Analysis continued
Net cash flow from investing activities is negative. In 2005, it was $95,000 and in 2006 it was $79,000. A negative cash flow under investing activities is not necessarily unfavourable. In this situation, the negative cash flows were due to the purchase of non-current assets. Purchase of such assets can signal growth or replacement of assets that are needed to improve revenue-earning potential.
Net cash flow from financing activities is negative. In 2005, it was $48,000 and in 2006 it was $30,000. Similar to investing activities, a negative cash flow here is not necessarily unfavourable. In this situation, the negative cash flow was due to the repayment of debt. Debt repayment is good as it may imply that the riskiness of the business is being reduced.
© Mary Low

12. Situation 1 – Analysis continued
Overall, SPACE-IOUS Cars Ltd has a very good cash position as it is generating significant positive cash flows from its operating activities. This has allowed the business to purchase more assets, to repay debt and to increase its overall cash position.
© Mary Low

13. Situation 2 - Details Statement of Cash Flows for the year ended
31 March 2005
31 March 2006
Cash flows from Operating Activities
Receipts from customers
$2,381,000
$3,011,000
Payments to suppliers
(1,940,000)
(2,530,000)
Payments for operating expenses
(980,000)
(990,000)
Interest paid
(43,000)
(22,000)
Tax paid
(45,000)
(53,000)
Net cash flow from operating activities
(627,000)
(584,000)
Cash flows from Investing Activities
Sale of non-current assets
95,000
79,000
Net cash flow from investing activities
Cash flows from Financing Activities
Share issues
92,000
52,000
Loan financing
280,000
250,000
Net cash flow from financing activities
372,000
302,000
Net Increase (Decrease) in cash
($160,000)
($203,000)
Opening cash balance
25,000
(135,000)
Closing cash balance
($135,000)
($338,000)
© Mary Low

14. Situation 2: Question 1
The overall cash position in SPACE-IOUS Cars Ltd in Situation 2 is…
Favourable or Unfavourable?
Select the your answer by clicking on the appropriate box below.
Favourable
Unfavourable
© Mary Low

15. Situation 2: Question 1 – Favourable?
The overall cash position in SPACE-IOUS Cars Ltd in Situation 2 is…
You chose “Favourable”
The overall cash position in SPACE-IOUS Cars Ltd is Unfavourable.
Look again at the Statement of Cash Flows.
(Click on the small image to get there.)
© Mary Low

16. Situation 2: Question 1 – Unfavourable?
The overall cash position in SPACE-IOUS Cars Ltd in Situation 2 is…
Unfavourable.
Well done!
The overall cash position in SPACE-IOUS Cars Ltd is unfavourable.
© Mary Low

17. Situation 2: Question 2
Q: What is the most important category of activity to look at in the evaluation of the cash position in Situation 2?
If you need to, look again at the Statement of Cash Flows.
(Click on the small image to get there, then come back to this slide, number 17.)
Select your answer by clicking on the appropriate box beside the activity.
Operating activity
Investing activity
Financing activity
© Mary Low

18. Situation 2: Question 2 – Investing activity?
You chose:
“Investing activity”
No, this is not the most important category to look at in this situation. You need to look at the operating activity category. Because the operating activity has not been generating positive cash flows, it can be argued that this has impacted on the investing activities by causing the sale of assets to help fund the running of the business.
Click on the green arrow to go back to the question.
© Mary Low

19. Situation 2: Question 2 – Financing activity?
You chose:
“Financing activity”
No, this is not the most important category to look at in this situation. You need to look at the operating activity category. Because the operating activity has not been generating positive cash flows, it can be argued that this has impacted on the financing activities by increasing debt borrowings and share issues to help fund the running of the business.
Click on the green arrow to go back to the question
© Mary Low

20. Situation 2: Question 2 – Operating activity?
You chose:
“Operating activity”
Well done!
This is the most important category of activity to look at in this situation. From the information available, SPACE-IOUS Cars Ltd have not generated any positive cash flows from operating activities for 2 (could be more) years. Negative cash flows from operating activities will impact on investing and financing activities and the overall solvency of the organisation.
© Mary Low

21. Situation 2: Question 3 – evaluating investing activity
Q: How would you evaluate the investing activity category in Situation 2?
Favourable or Unfavourable?
Select the your answer by clicking on the appropriate box below.
Favourable
Unfavourable
If you need to, look again at the Statement of Cash Flows
again. (Click on the small image to get there.)
© Mary Low

22. Click on the green arrow to go back to the question
Situation 2: Question 3 – evaluating investing activity – favourable? Are you sure?
Q: How would you evaluate the investing activity category in Situation 2?
Favourable or unfavourable?
You chose:
“Favourable”
Not really in this situation. Although it is generating positive investing cash flows, it can be argued that assets are being sold off to help the organisation generate cash for the running of the business.
Click on the green arrow to go back to the question
© Mary Low

23. Situation 2: Question 3 – evaluating investing activity – unfavourable
Situation 2: Question 3 – evaluating investing activity – unfavourable?? Well done!
Q: How would you evaluate the investing activity category in Situation 2?
Favourable or unfavourable?
You chose:
“Unfavourable…”
Yes, that is correct in this situation. Although it is generating positive cash flows, it can be argued that assets are being sold off to help the organisation generate cash for the running of the business.
© Mary Low

24. Situation 2: Question 4 – evaluating financing activity
Q: How would you evaluate the financing activity category in Situation 2?
Favourable or Unfavourable?
Select the your answer by clicking on the appropriate box below.
Favourable
Unfavourable
If you need to, look again at the Statement of Cash Flows
again. (Click on the small image to get there.)
© Mary Low

25. Click on the green arrow to go back to the question
Situation 2: Question 4 – evaluating financing activity – favourable?? Are you sure?
Q: How would you evaluate the financing activity category in Situation 2?
Favourable or unfavourable?
You chose:
“Favourable”
Not really in this situation. Although there are positive cash flows in this category, it can be argued that there is still significant loan (debt) borrowings to help fund the running of the business.
Click on the green arrow to go back to the question
© Mary Low

26. Situation 2: Question 4 – evaluating financing activity – unfavourable
Situation 2: Question 4 – evaluating financing activity – unfavourable? Well done!
Q: How would you evaluate the financing activity category in Situation 2?
Favourable or unfavourable?
You chose:
“Unfavourable….”
Yes, in this situation. Although there are positive cash flows in this category, it can be argued that there is still significant loan (debt) borrowings to help fund the running of the business. It is important that there is positive cash flows from operating activities otherwise the business will not be able to survive in the longer term. A business cannot continue to borrow or sell off assets to fund its operations.
© Mary Low