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Small Business Credit: Analyzing Cash Flows: Bringing it all together

Cash after financing costs

Cash Flow Summary

Jasmine and Co.

  

2010

Interest expense

-600

? Interest payable

0

Dividends declared

0

? Dividends payable

0

Cash paid for dividends and interest

-600

Cash after financing costs

15,000

Figure 8: Extract Cash flow Summary- Cash after financing costs

The next segment deals with interest and dividends. Jasmine and Co.’s has not paid any dividends and there is no change in interest payable. Only an amount of 600 has been paid on account of interest expenses which will be included here.

Adding this amount to the running balance we arrive at Cash after financing costs of $15,000. We can assess that Jasmine & Co. has sufficient internally generated funds to pay interest expense. A bank would next need to evaluate if the remaining cash is enough to service the company’s debt. If on the other hand had the funds generated not been sufficient (i.e. a negative amount), a bank would need to determine whether the loan proceeds that Jasmine & Co. are applying for was for the purpose of meeting these interest payments.

Cash after debt amortizations

Cash Flow Summary

Jasmine and Co.

  

2010

Current portion long-term debt (prior year)

0

Cash after debt amortization

15,000

Figure 9: Extract Cash flow Summary- Cash after debt amortization

This segment includes the current portion of Jasmine & Co.’s long term debt that the company has to pay within the next year. As can be seen from the financing statements this is zero. Therefore the running balance informs us that cash after debt amortization is $15,000. Jasmine & Co. has sufficient internally generated cash to cover both financing costs and debt obligation. If on the other hand had the cash balance after debt amortization been negative a bank processing Jasmine & Co.’s loan application would try assess how the company’s existing debt could be restructured or reduced.

Financing surplus (requirement)

Cash Flow Summary

Jasmine and Co.

  

2010

? Fixed assets

-10,000

? Intangibles

0

? Investments

0

Cash paid for fixed assets and investments

-10,000

Financing surplus (requirement)

5,000

Figure 10: Extract Cash flow Summary- Financing surplus (requirement)

Changes in fixed assets, intangible assets and investments are included within this segment. During the year, there was a purchase of fixed assets worth $10,000. We arrive at this figure by subtracting opening fixed assets from closing fixed asset and adding back depreciation for the year, i.e. 33,000 – 25,000 + 2,000 = $10,000.

There was no change in the intangible assets or investments so subtracting this figure from the running balance we arrive at a financing surplus of $5000.

Financing surplus (requirement) + Total external financing

Cash Flow Summary

Jasmine and Co.

  

2010

? Short-term debt

0

? Long-term debt

-6,000

? Preference shares

2,000

? Ordinary shares

0

Total external financing

-4000

Financing surplus (requirement) + Total external financing

1,000

Figure 11: Extract Cash flow Summary- Financing surplus (requirement) + Total external financing

In this last segment we take in to account any changes in the financing of the company. During the year loan repayment of $6,000 was made, which will be deducted from cash, and additional preference shares worth $2,000 were issued which will be added to cash. These changes result in a running balance of finance surplus requirement plus total external financing of $1000.

A bank would look at this section to understand how the company has financed its need for external sources of cash and whether it has done so appropriately. It would also assess whether the new financing that it seeks is appropriate in relation to the existing financing structures in place.

Note that the final running balance is equal to the actual change in the cash balance during the year (=16000-15000).

Below we merge all the segments together to present the entire cash flow summary:

Cash Flow Summary

Jasmine and Co.

  

2010

Sales

37,300

? Accounts receivables

-300

Cash collected from sales

37,000

  

  

Cost of inventory sold

-15,400

? Inventory

500

? Accounts payables

1,500

Cash paid for production

-13,400

Cash from trading activities

23,600

  

  

Operating expenses (less non-cash expenses)

-8,500

? Prepaid expenses

100

? Accrued expenses

200

Cash paid for operating costs

-8,200

Cash after operations

15,400

  

  

Other income (expenses)

0

? Other current and non-current assets

2000

Tax

-1,600

? Deferred Tax

0

? Tax payable

-200

Tax paid and other income/expense

200

Net cash after operations

15,600

  

  

Interest expense

-600

? Interest payable

0

Dividends declared

0

? Dividends payable

0

Cash paid for dividends and interest

-600

Cash after financing costs

15,000

  

  

Current portion long-term debt (prior year)

0

Cash after debt amortization

15,000

  

  

? Fixed assets

-10,000

? Intangibles

0

? Investments

0

Cash paid for fixed assets and investments

-10,000

Financing surplus (requirement)

5,000

  

  

? Short-term debt

0

? Long-term debt

-6,000

? Preference shares

2,000

? Ordinary shares

0

Total external financing

-4000

Financing surplus (requirement) + Total external financing

1,000

  

  

Proof: ? Cash and marketable securities

1,000

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Figure 12: Cash flow Summary

 

Cash flow statement

Since we now know how to prepare a cash flow summary, we will review how a cash flow statement is drawn up in order to complete our cash flow analysis. The preparation of the cash flow summary should aid the reader in preparing a cash flow statement.

The cash flow statement for Jasmine & Co. is presented below. This is followed by an explanation of how it was prepared.

Jasmine and Co.

Cash flow statement for the year ended 31 Dec. 2010

  

$

Cash flows from operating activities

  

Cash received from customers

37,000

Cash paid to suppliers and employees

-19,600

Net cash from operating activities

17,400

  

  

Returns on investments and servicing of finance

  

Other income

0

Interest paid

-600

Dividends paid

0

Cash from returns on investment and servicing of finance

-600

Taxation paid

-1,800

  

  

Investing activities

  

Purchase of fixed assets

-10,000

  

  

Net cash flow before financing

5,000

  

  

Financing

  

Payments for long-term debt

-6,000

Issue of share capital

2,000

Net cash flow from financing

-4,000

  

  

Increase in cash

1,000

  

  

Net change in cash

1,000

Plus cash at the beginning

15,000

Cash at the end of the year

16,000

Figure 13: Cash flow statement-direct method

The statement is divided into five parts:

  • Cash flow from operating activities,
  • Cash from returns on investments and servicing of financing,
  • Taxation,
  • Investing activities, and
  • Financing activities.

The cash received from customers in the cash flow statement above equals the figure for cash collected from sales from the cash flow summary.

Cash paid to suppliers and employees in the cash flow statement above is the sum of the cash paid for production, cash paid for operating cost and the change(?) in other current and non-current assets as given in the cash flow summary.

The other figures too have been taken from the cash flow summary and are self explanatory.

The method employed above for preparing the cash flow statement is called the direct method. The alternative method of drawing up the statement is by using the indirect method. The only difference between the two methods is in the way in which ‘cash flow from operating activities’ is prepared. The indirect method takes a different approach by starting with net profit and works backwards adding non-cash expenses and balance sheet changes that released cash and subtracting non cash revenues and balance sheet changes that used cash. The cash flow from operations is calculated using the indirect approach for Jasmine & Co. below (a more detailed review of this method is given in our course “Accounting Crash Course: Small Business Accounting: Cash flow statement”):

Jasmine and Co.

Cash flow statement for the year ended 31 Dec. 2010

Cash flows from operating activities

$

Net operating profit

11,400

Adjustments:

  

Depreciation

2,000

Changes in accounts receivables

-300

Changes in accounts payables

1,500

Changes in inventory

500

Changes in prepaid expenses

100

Changes in accrued expenses

200

Changes in other assets and liabilities

2,000

Net cash from operating activities

17,400

Figure 14: Cash flow from operating activities- indirect method

As you can see both methods give the same result for net cash from operating activities (=$17,400).

To recap, cash flow analysis is an important aspect of a bank’s evaluation of a company’s loan application. It helps them to assess the company’s current cash flows and more importantly its ability to meet its future obligations in particular its capacity for repaying the loan.

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