Cash from Trading Activities
Cash Flow Summary
Jasmine and Co.
Cost of inventory sold
? Accounts payables
Cash paid for production
Cash from trading activities
Figure 5: Extract Cash flow Summary- Cash from trading activities
The next item that we need to calculate is the cash that has been paid for production. This is the amount that Jasmine & Co. paid for the items they sold. To arrive at this figure we start off with the cost of inventory sold from the income statement for the year. Consider how the cost of inventory sold is calculated; to the opening inventory we add purchases and subtract the closing inventory. To arrive at purchases therefore we work backwards; to the cost of inventory sold we add (subtract) the decrease (increase) in inventory. However, this purchases figure would still include those purchases for which Jasmine & Co. hasn’t as yet paid cast. We would need to remove these credit purchases from the derived purchases amount. To do this we will add (subtract) any increase (decrease) in accounts payables. This is what has been done in figure 5 above.
Next we calculate the cash from trading activities. This is arrived at by adding cash collected from sales with the cash paid for production i.e. 37,000 + (-13,400) = $23,600. This running balance will flow through the cash flow summary.
Cash flow analysis
- Changes in cost of inventory sold as a percentage of sales:
- This is calculated as (Cost of inventory sold/Sales) x 100
For 2009 it was: 37% and for 2010 it is: 41%
- Changes in inventory because of an increase in the cost of inventory sold:
- Cost of inventory sold has increased by 48%. All things equal we would expect our closing inventory to also increase by 48%, i.e. by $3,846 (=8000 x 0.48). However, the Inventory balance in 2010 has declined. We therefore believe that this expected increase is countered by a decrease in the inventory turnover ratio. We explore this further below.
- Change in inventory as a result of changes in inventory turnover:
- Inventory turnover is calculated as (Inventory/Cost of inventory sold) x 365
In 2009 the inventory turnover was 281 days and in 2010 it declined to 178 days. There is a decrease of 103 days in inventory turnover. Note that this is expected as the inventory balance declined despite the fact that cost of inventory sold increased.
- Average daily cost of inventory sold:
- The average daily cost of inventory sold is calculated as Cost of Inventory sold/ 365. For 2010 it was $42.2.
- The impact of the decline in inventory turnover is calculated by using the results of c and d above. Multiplying the decrease in turnover with the average daily cost we get a decrease in the inventory of $4,346. Considering the effects of the increase in the cost of inventory as well as the decline in inventory turnover, the net impact on the cost of inventory sold is a decline of $500
- Changes in account payables due to changes in cost of inventory sold:
- All things equal we would expect the account payables to increase by the increase experienced in the cost of inventory sold, i.e. 48% or by $2,644 (=5,500 x 0.48). However the increase in account payables is not as large as this. This is due to a decrease in the creditors turnover ratio as explained below.
- Changes in accounts payables as a result of changes in creditors turnover ratio:
- The creditors turnover is calculated as (Accounts payables/Cost of inventory sold) x 365. It represents the number of days Jasmine & Co. takes to pay off their creditors.
In 2009 the creditors turnover was 193 days and in 2010 it was 166 days in 2010, a decline of 27 days.
As calculated in d above the average daily cost of inventory sold in 2010 is $42.2. Multiplying this with the decline in creditors turnover works out to a decrease in Accounts payable of $1,144. The net effect of an increase in the cost of inventory and a decline in the creditors turnover is an increase in Accounts payables of $1,500.
Once we have carried out the quantitative analysis we will perform a qualitative analysis on the results. We will look into the reasons for decreases in the inventory and creditors turnovers to assess whether it can be sustained in the future or whether it was just temporary. We will consider what factors could have influenced such a large increase in the cost of inventory, whether it was due to an industry wide impact or due to business or management actions.