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There are 2 methods generally used for Cash Flow Analysis:

— Direct method;

— Indirect method.

The Direct Method is based on the information presented in the CASH accounts. It shows (1) the main sources of cash inflow and main trends in cash outflow, (2) it provides the possibility to make operational decisions on sufficiency of cash for current payments, (3) it establishes the connection between the total revenue and cash revenue for a reported (accounting) period.

In order to outline the report, Accounting Journals for the following accounts are required:

Cash on hand (account 241);

Bank accounts (account 242 and 243);

Cash equivalents (accounts 244, 245, 246).

On the debits’ side Cash Inflows are shown and the credit side reflects cash uses. The Cash Flow Statement is constructed through the summarization of debits and credits of the listed accounts, which is a simple procedure.

The Indirect Method is based on the correlation of the Net Income and the occurred changes in the Balance Sheet for a given accounting period. Any business transaction implies changes in the Assets or Liabilities side of the Balance Sheet, which is a movement of funds through the accounts of the company.

The summarized Cash Flow Statement allows the analyst to perform a sound analysis of:

— The managerial decisions quality over certain period of time;

— The size an composition of cash from operations, as well as their pattern and degree of stability

— The impact of the operating activity on the financial stability of the company.

The three following aspects of company’s activity are analyzed:

— Operating activities;

— Investment activities;

— Financial activities.

Operating Activity

Cash Flow from Operating Activities includes cash inflows and payments related to the core activity of the company (Sales, Procurements). The operating activity is the main source of cash.

Inflows from Operating Activity:

— Cash;

— Collection of accounts receivable;

— Advances received from clients;

— Sale of goods received through barter transactions;

— Other cash inflows.

Outflows from Operating Activity:

— Payments to suppliers and subcontractors;

— Salary payments;

— Taxes, Social Security, and medical insurance charges;

— Interest payments;

— Sponsoring and Social costs.

Investing Activity

Cash Flow from Investment Activities includes inflows from sales of fixed assets, as well as investments and payments for fixed assets replacement. Profitable companies usually extend their business and upgrade their production capacities, so a cash deficiency may occur in short run.

Inflows from Investing Activity:

— Disposal of fixed asset;

— Dividends related to long term investments;

— Interest received;

— Sale of daughter companies;

— Other inflows;

Outflows from Investing Activity:

— Acquisition of fixed and intangible;

— Capital investments;

— Acquisition (of other companies);

— Long-term financial investments.

Financing Activity

The Cash Flow from Financing Activities includes inflows from loans and credits, also from stock emission and payments in order to reimburse or to redemption of shares. The cash flow from financial activity should contribute to the balancing of financial needs of investment and operational activities.

Inflows from Financing Activity:

— Short-term credits and loans;

— Long-term credits and loans;

— Receipts from issuing shares;

— Subsidies;

— Other inflows.

Outflows from Financing Activity:

— Repayment of sort-term and long-term credits and loans;

— Payment of dividends;

— Redemption of shares.

Cash Flow Ratios

Minimal Cash Requirement

SPT — aggregate cash outflow from the company during a given period P — period in days

AAI — average age of inventory from the time of purchase to the time of sale (days) APR — average period of payment of accounts receivables (days)

APP — average period of payment of accounts payable (days)

Time Interval During which the Company can Operate without Cash Inflows

CF — cash funds

AR — balance of accounts receivable ADOE — average daily operational expenses

Cash Reinvestment Ratio

This ratio reflects how much cash from operational activity contributes to the replacement (renewing) of the assets and to increase of the operational level of the company. It is calculated as follows:

CFOA — Cash Flow from operational activity

D — dividends paid

LTA — long term assets

I — investments

WC — working capital

It is considered that a ratio of 8 — 10% is satisfactory, that means that operating activity of the company generates enough cash in order to meet its own investment needs.

Cash Flow Adequacy

This example shows that the operational activity does not generate enough cash to meet the necessities for increasing the operational level, thus some loans or other forms of borrowings were required.

Cash Reinvestment Ratio

It is thoroughly considered that a Cash Reinvestment Ratio of 10 — 12% positively characterizes the cash flow generating power of the company, that is the renewal of fixed assets and other components of the asset side are completed in 8 — 10 years.

Tagged as: Cash Flow, financial analysis