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An Introduction to Cash Flow Analysis

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Sub: Finance                                                                     Topic: Cash Flow Analysis

An Introduction to Cash Flow Analysis

Cash flow statement does not take into account the offsetting movements among the individual
current assets and liabilities. An increase or decrease in the individual elements (other than cash) and
liabilities affect cash in different ways. For example, an increase in sundry creditors and bank
overdraft have different implications in terms of repayment of cash. Sundry creditors' bill may fall due
after one month or two months.


However, bank overdraft facility may be for a longer duration and thus it is possible that the firm is in
a sound financial position as reflected by the amount of net working capital but it has difficulty in
meeting its short term commitments. For this purpose, cash flow statement is prepared and its
analysis is conducted to assess the ability of the firm to meet its obligations to trade creditors, bankers
and to pay interest to debenture holders and dividend to its shareholders.


Cash flow analysis takes a more conservative approach about the liquidity position of the firm by
taking a limited view of the pool of funds available to the firm. It is cash and cash equivalent items
only that form the liquidity position of the firm according to this view. When cash basis is adopted for
analysis, slight modifications are made in the steps suggested earlier for fund flow analysis. Now
instead of net working capital, the focus shifts to change in the cash account and the following are
some of the ways by which the cash flow takes place:


Sources of cash:


   1. Net decrease in current assets other than cash;
   2. A gross decrease in fixed assets;
   3. A net increase in any current liability;
   4. A net increase in any noncurrent liability;

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Sub: Finance                                                                     Topic: Cash Flow Analysis
   5. Proceeds from the sale of equity/preference shares;
   6. Cash from operations


Uses of cash:


   1. Net increase in any current assets other than cash;
   2. A gross increase in fixed assets;
   3. A net decrease in any current liability;
   4. A net decrease in any non current liability;
   5. Redemption of preference shares or loans;
   6. Cash dividends and
   7. Cash lost in operations.


In order to find out the changes in net working capital, either non-current or current items are to be
found out and for this purpose, all non cash balance sheet accounts are to be analyzed to look for
change in cash account. The changes in current assets and current liabilities form a part of the
operating cycle of the firm and the impact of these changes on cash can thus be readily captured by
approximately adjusting the net income from operations.

Uses of cash flow analysis:


Cash flow statement is similar to funds flow statement except that it focuses attention on cash instead
of working capital and a careful look into the cash flow statement can help to answer the following
questions:


   1. How much is the amount of cash?
   2. How much change has taken place in cash over time?

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Sub: Finance                                                                     Topic: Cash Flow Analysis
   3. How much cash is provided by operations of the business?
   4. Is there a proper balance between various sources of cash?
   5. How much cash is used?
   6. For which purpose the cash is used?


The answers to the abovementioned questions based on cash flow analysis can greatly facilitate the
management of the structural health and liquidity aspects of working capital effectively.




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 *The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for
                              submitting the same in lieu of their academic submissions for grades.
Sub: Finance                                                                      Topic: Cash Flow Analysis

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