Analyzing movement of cash during the Operating Period

Views: 27 Comments: 0 0 Post Date: February 21, 2019

We as a finance professional, are familiar with the three financial statements viz Income Statement, Balance Sheet & Cash Flow Statements. These financial statements are prepared by every company, firm, or business to quantify their earnings (in the from of Income Statements) and reporting the closing balances of their assets and liabilities for the specified period. In Balance Sheet we usually see the difference in the balances of respective Assets & Liabilities as on previous period ending date and current period ending date, which are resulted by the operations during the period.

In this article we are going to discuss the movement of cash with respect to operations (i.e. Incomes/Expenses incurred for a period) and the effects of such operations on the balances of the various assets and liabilities (operating and non-operating) in the Balance Sheet. To analyses the movement of cash during the period we prepare the Cash Flow Statements. It is fact that net Income/Loss in Income Statement is not only the key parameters for reflecting the increase/decrease of cash balance in the balance sheet. There are other components of operations during the period, which affects the cash balance.

Methods for Preparing Cash Flow Statements:

The cash flows statements are generally prepared by two methods Direct Method and Indirect Method.

DIRECT METHOD: In this method of calculation, the actual flow of cash (in payments and receipts) generally identified in the financial statements prepared on cash basis, which is not available in current era. The below is the format for evaluation of closing cash balance after adjusting all the payments and receipts during operations for respective period.

Cash Flow Statements

INDIRECT METHOD: This method comes into existence after transferring of accounting system from cash basis to accrual basis. In Accrual Basis of accounting, the transaction (either income/expenses) are recorded at the time of occurrence. It does not matter, whether the cash is received or paid for respective income/expense at the time of transaction. The Accrual method of accounting results in the creation of various payables, receivables accounts to record the balances in the current assets / liabilities in the balance sheet.

In such accrual method of accounting, the statement of cash flows statements is prepared to reconcile the change in cash balance during the period with respect to earnings, non-cash charges, changes in balance sheet accounts (i.e. Working Capital), capital expenditures and other investments (i.e. Non-Current Assets), and transactions with lenders and shareholders (i.e. Debt, Non-Current Liabilities and Equites).

The followings are the key segments categorized in the Cash Flow Statements.

Cash Flow Statements

The three main core segments of cash flow statements are categorized for the analyzing the movement of cash as discussed below –

  1. Cash Flow from Operating Activities – As discussed above that the net income/losses do not referred as net change in balance of cash during the period. In accrued method of accounting, to capture the actual cash flows with respect to the operations during the period need adjustments for reconciling the actual cash flows. The such adjustments are discussed as below –
    • Non-Cash Charges – There are some expenses which are charged in the income statements, but in actual they are either not incurred or no cash outflows with respect to such expenses e.g. depreciation and amortization, Accrued interest cost, Stock based payments (ESOPs etc.) to employees etc. Such expenses are need to be added back to net income to arrive at cash operating income for a period.
    • Realized gain or losses – In Income Statements there are some incomes/losses which are due to sale of the assets, investments. The difference between the book value and sale value of such assets/investments leads to gain/loss in respective transaction. Considering these gain/losses as a non-operating income/expense we exclude this (by adding back the expenses or deducing the gains (as the case may be) for portraying the organic cash operating profit for the firm/company for a period.
    • Adjustments of other non-operating incomes/expenses – As discussed above, apart form realized gain or loses there are some other expenses which are non-operating in nature like restructuring costs or other non-recurring expenses and impairment gain/losses in the value of respective asset. Such expenses shall also be added back to evaluate the Net Opearting cash flows before changes in the working capital.
    • Changes in Working Capital – This is the final adjustments to evaluate the actual cash flows because of the changes in the current assets (excluding cash & cash equivalents) and current liabilities (excluding short term debt & current portion of long-term debt). Current asset includes Inventory, Account Receivables, Prepaid Expenses and Other Current Assets, similarly current liabilities includes Account Payables, Accrued Revenue and Other Current Liabilities etc.

The methodology used in evaluation of the changes in working capital is –

If there is an increase in balance of current assets (in current period as compared to previous period), this represents that the cash goes out of business for creation of such assets and vice versa. Similarly, in case of current liabilities, it is concluded that the cash is goes out of the business if there is decrease in balance of current liabilities (in current period as compared to previous period) and vice versa.

Working Capital is also referred as Net Current Assets (i.e. Current Assets – Current Liabilities). Hence applying the methodology as discussed above, if there is an increase in working capital in current period as compared to previous period, it will be concluded that the cash has been moved out of the business.

  1. Cash Flow from Investing Activities – Similarly as done for change in working capital, the same methodology is followed in evaluation of cash flows from transaction in non-current assets. It provides us the details of cash outflows for capital expenditures, Acquisitions of assets/investments and inflows of cash are arising from disposal of assets, investments, dividend/interest incomes etc.
  2. Cash Flow from Financing Activities – In evaluation of cash flows from transaction related to Debt, Equity, and other non-current liabilities the same methodology is followed as discussed above in case of working capital (current liabilities). It provides us the information about cash outflows as Debt repayments, Dividend/Interest payments, other financing fees payments etc. and similarly cash inflows arising from funds raising by Debt or Equity.

The aggregation of the changes in cash across the 3 core segments, discussed above, give us the overall change in the cash (net of inflows and outflows) over the period for a business/firm/company. The aggregate change in cash is added to the cash balance as reported in previous period’s balance sheet. This results in the closing cash balance which is reflected as the cash balance at the end of the current period.


While Analyzing the cash flow statements the two core relationships are discussed as –

  • The Relationship between Operating cash flows and Investing cash flows: In this relationship we evaluate the operating performance of the business, whether management is efficient for positive cash earnings from operations and effective disposal of assets/investments for internal funding of required capital expenditures. If management manages to fund the capital expenditure from internal sources (i.e. by cash flows from operations and disposal of assets/investments) then there will be no need to take debt, hence representing sound financials. The excess internal sourcing of finance i.e. cash left after committing capital expenditure, helps the management to either payoff the debt (if any in the books) or to make investments, acquisitions for inorganic growth in future, which is again a positive in terms for sound business operations. The reverse is considered as the business is more dependent on outsider funds (either equity or debt) which is generally not considered as efficient business operations, as outsider liabilities are troublesome in inflationary economic conditions or in down cycle of business.
  • The Relationship between transactions with lenders and Transactions with share holders (in Cash flow from Financing): This relationship correlates to the changes in the capital structure of the firm. It comes into existence when management is more concern on funding the capital expenditures for their expansion, where they do not have appropriate cash flows from operations and even cash inflows form sale of assets/ investments. For funding the same management prefers debts as marginal cost of debt (in case there are lower borrowing rates in market) is less than marginal cost of equity. Also in case of positive cash flows form operating and even investing activities, management will focus on de-leverage the balance sheet and opting for returning cash to shareholders through share repurchase or dividends. However, in case of inflationary cycle of economy, where cost of debt is high, management will be inclined towards issuing the shares instead of raising debt at high cost. Also, in this scenario, if there are positive cash flows in operating activities and investing activities, management will also be encouraged towards repayment of debt (if any in their books) to reduce the interest cost for improving net margins.

Author: Paramjit S. – Sr. Analyst


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