Month: October 2022

When analyzing a potential investment opportunity, profitability is often the ultimate deciding factor. Without knowing how profitable an investment will be, it’s impossible to tell whether that opportunity is worth your time or money. To make this decision, you need to analyze the cash flows of the project being considered. Here is a brief overview of three cash flow types and their meanings.

What is a Cash Flow?

A cash flow measures how much cash is generated or used by a company in a certain period. Cash flow is often confused with net income, but they are two very different things. Net income is a company’s profit after accounting for all expenses, deductions, and taxes. On the other hand, cash flow is a measure of the cash that a company generates.

In other words, it’s the amount of money a company brings in less the amount it spends. To determine the amount of cash a company has generated or used in a specific period, accountants will use a “cash flow statement.” This statement lists every cash flow event during a particular period, such as a company’s daily operations, an investment in another company, or a dividend payment to shareholders. Cash flow statements are prepared using the accrual method of accounting, which means that they record events when they are incurred, not when they are paid.

When Is Cash Flow Analysis Important?

The cash flow generated by a business is its lifeblood. Cash is needed to fund day-to-day operations, long-term investments, and debt repayments. If a business doesn’t have enough money, it can’t pay its bills on time and could face serious consequences, such as lawsuits, repossessions, or even bankruptcy.

A company’s cash flow is determined by three things:

• How much cash it is bringing in
• How much cash it is spending
• How it finances its activities

The cash flow statement differs from the income statement, which measures profitability. Cash flow analysis is the process of studying a company’s cash flow statement to determine its financial health.

Cash Flows From Operations

Operating cash flows are generated by a company’s daily operations, such as sales and collections of receivables. This is the cash flow that most people think about when they discuss the cash flow of a business. Businesses with healthy operating cash flows are more likely to be financially successful.

There are many factors that can affect operating cash flows, including the price of the product or service being sold, the cost of materials, and the time customers take to pay their bills. Operating cash flows are also known as “continuing operating cash flows” because they are expected to continue over the long term. These cash flows do not depend on financing or the sale of assets. Below are the three types of cash flows.

Cash Flows From Investments

These cash flows are generated by the company’s investments in other companies and intangible assets, such as patents and trademarks. A company may also invest in tangible assets, such as real estate, machinery, equipment, or inventories. Investments in these types of assets are known as “financing activities that require payment of cash.” When a company invests in another business, the transaction may involve the payment of cash, securities, or other assets.

The investment might also be made by purchasing a company’s bonds or stocks. When a company makes an investment that does not require cash payment, such as when it purchases intangible assets, it is considered a “financing activity that does not require payment of cash.”

Cash Flows From Financing Activities

Financing activities involve using cash, such as when a company repays debt or makes dividend payments to shareholders. Financing activities that do not require cash payment are called “investments that do not generate cash.”

Making a payment on a loan is an example of a financing activity that uses cash. Companies also make payments to their shareholders, either by paying out dividends or buying back company stock. These types of payments do not require the use of cash.

Conclusion

Cash flow analysis is essential for understanding how a business generates, uses, and manages its cash. A company’s operating cash flows represent its current cash flow, while cash flows from investments represent a company’s future cash flow potential. Knowing how much cash is flowing in and out of a company can help you determine your company’s financial health and identify potential problems before they become serious.

Business ethics is a system of ethical and moral beliefs that guides the operations and behaviors of a company and its employee. It displays an organization’s goals, values, and how it conducts its daily operations.

Some ethical principles in many businesses include honesty, integrity, fairness, loyalty, respect, trustworthiness, corporate social responsibility, and accountability. Below are the benefits companies get when they implement good business ethics.

Good Public Image

This is the leading benefit organizations get from good business ethics. They make the company stand out among clients, shareholders, and partners. Customers are more likely to return to an honest company that contributes to society, is fair to its employees, and takes accountability for their mistakes. They are also more likely to suggest it to more people.

It will also attract more and better partners and shareholders, increasing the company’s positive reputation and relationships. Investors are also likely to make repeat and higher investments in the company or refer more investors.

Employee Loyalty

Employees love working in places where they are appreciated, listened to, and cared for. With practices like fairness, employees are sure to get paid according to their job and get promotions according to merit.

Business ethics also help prevent any bad practices in the company, like bullying or discrimination because of color, race, religion, or gender. This increases employee retention, saving the company money and time they would have used to hire and train more employees.

It also makes the company stand out among competitors, increasing the chances of hiring the best talent in the market when it comes time to add to their team.

Good business ethics also create an open and free environment in the organization, making it easy for employees to communicate with upper-level managers. Since employees are the ones who interact on a more personal level with clients and have a hands-on experience with the organization’s operation, open communication channels will help employees suggest more effective solutions to some issues in the organization.

This increases employee creativity, innovation, and satisfaction, making them more productive. This benefits the organization by increasing sales and avoiding issues like employee strikes or boycotts.

Reduces Company Losses

It does not take long for word to spread about a company, which also applies to negative aspects. When a company has negative practices or bad ethics, it will suffer in terms of negative reviews and low ratings. In the age of social media, it only takes a few clients to make negative posts or comments about the company for more people to see.

This affects the company by losing old clients and the inability to attract new ones. To reverse their image, the company will invest in positive publicity by increasing advertisements and partnering with well-known people like celebrities.

This sometimes does not work and requires the company to revise most of its operations. Through these efforts, the company loses more money than it would have if it had good ethics.
When the negative publicity spreads, the company’s stock prices might also decrease, discouraging new and existing investors from buying them.

It might also result in authorities’ investigation of the company, leading to its closure. Alternatively, the company might suffer irrecoverable losses, leading to its closure.

Conclusion

No matter the type and size of an organization, business ethics play an essential part in its success or failure. The key to having good business ethics is communicating with employees and customers. After developing ethics, managers should take their employees through them and be good role models.

Companies should also praise and reward employees holding up their ethics, encourage employees to report unethical behavior, and punish unethical employees. Managers should also ensure they are updated with business and society trends and update their ethics to match them.

Free cash flow is defined as the net balance begot from the operations of a business across a specific financial period. In basic terms, free cash flow can be described as the amount of money that is freely available after paying all financial commitments or operating costs after a specific financial period.

To many people, free cash flow (FCF) provides little clarity since there is a blurred understanding of FCF in mainstream economics. The two main types of free cash flow are as stated below.

• Free cash flow to the firm
• Free cash flow to equity

Free Cash Flow to the Firm (FCFF)

Also called “unlevered,” FCFF is the amount of money available for spending after deducting taxes, working capital, investments, and depreciation. FCFF is a robust benchmarking method used to analyze a company’s financial health. FCFF measures a firm’s profit after expenses and reinvestments. Free cash flow to the firm represents the cash available for expansion after a company deducts all its financial obligations.

Numerous methods are used to calculate FCFF, but they are all supposed to yield the same result. The most commonly used formula is highlighted below.

NI + NC + (I × (1 – TR)) – LI – IWC = FCFF

• NC = Non-cash charges
• NI = Net income
• TR = Tax Rate
• I = Interest
• LI = Long-term Investments
• IWC = Investments in Working Capital

Free Cash Flow to Equity (FCFE)

FCFE basically determines the amount money available for equity shareholders after all expenses, debt, and reinvestments have been paid. FCFE comprises net income, working capital, capital expenditures, and debt. Financial inquisitors commonly utilize the FCFE metric to determine the practicality and benefits of a given company. When properly applied, the FCFE metric exposes whether dividend payments and stock purchases are paid to FCFE or other forms of financing. The most commonly used formula for calculating FCFE is shown below.

V equity= (r−g) FCFE

• FCFE = expected FCFE for next year
• R = cost of equity of the firm
• V equity = value of the stock for that day
• G = growth rate in FCFE for the company

Most importantly it is vital to understand the pros and cons of free cash flow. It is an effective method that helps stakeholders and shareholders understand how the business is faring. Free cash flow discloses relevant information about the company’s expenditure and the numerous methods that are used to secure the company’s investments.

Benefits of Free Cash Flow

A good FCF analysis provides relevant information to lenders and shareholders. It gives surety to lenders that the company is capable of servicing its debt. FCF is a vital measurement method that shows a company’s management quality. FCF shows the company how much is available for investment and how much can be allocated to shareholders.

Another important feature of a good FCF is that it informs the company and stakeholders about the future performance of the company. A good company that generates a positive FCF every financial year is a good prospect for investors, shareholders, and the company.

Constraints of Free Cash Flow

Since FCF applies the entire cost of capital expenditure where the property is acquired instead of spreading it over different periods as the main financial statement, this can give a wrong impression about a company’s financial position. Another aspect that negatively affects FCF is volatility. In cases with repeated capital expenditures over recurrent periods, especially after a few years, FCF can be volatile compared to net income.

FCF ignores the cost of debt services. Thus it may not necessarily reflect the ability of a company to manage its debts. It is also not a proper method when involving big companies that record huge debts every year.