11/27/2023 0 Comments Cash flow statement explainedIn fact, periods of steady growth make a good starting point from which to explore the impact of more dramatic situations (like rapid growth or recession) on cash flow. When a company enjoys steady sales, all’s right with the world and all’s right with each of the cash flow indicators we’re going to review-NIPD, EBIT, and NOCF”. Prime and double prime also show the circular nature of the problem the more priority outflows you have, the less you have available for discretionary out-flows, and the more you want in your necessary discretionary category, the less you have available for priority outflows. The “prime” and “double prime” are not used to be clever or different for difference’s sake rather, they point out a very important fact about a cash flow statement: everything starts with NOCF. In other words, this is the amount of money you will have to service your debt. What’s interesting about this statement is that two models can be derived from it to answer important questions that all managers ask: How much money will I have for my discretionary outflows (capital expenditures and dividends)? How much money will I have to service my debt? To answer these questions, we have to begin with NOCF-that is, how much money do I have from the company’s basic operations with which I can do things? The sum total of the statement, the net change in cash and marketable securities, is the amount of cash the company has left over. Periodic repayments of these loans come under the priority outflows section. The first is to pay interest and debt (priority outflows) the second, capital expenditures, R&D, and dividends (discretionary outflows) and the third, sale or repurchase of stock or term loans (financial flows). The next three sections detail what those things might be. If you subtract the operating cash outflows from the operating cash inflows, you get net operating cash flow (NOCF)-the amount of money a company has to do things. The statement’s first three sections (operating cash in-flows, operating cash outflows, and net operating cash flow) deal with the company’s basic operations. To project your capital requirements, you can use a cash flow statement like the one opposite. In this article, I will show first how I derived NOCF” from a cash flow statement and then how you can use it in a model to predict your company’s true cash flow picture under a steady sales scenario or explosive growth and during a recession. Called net operating cash flow-double prime (NOCF”)-the measure I developed shows the absolute minimum cash necessary for a company to service its debt. It seemed to me that a measure was needed to tell managers what their bottom cash line really was-how much money they had (or, when modeling for future scenarios, would have) to pay debts before spending on “frills” like R&D and capital expenditures. That may prove disastrous when you’re trying to decide whether to take on more debt obligations or trying to meet the ones you’ve already got. That’s because both are based on the company’s income statement and don’t include working-capital items-principally, accounts receivable, inventory, and accounts payable.įor that reason, when the corporate pendulum swings in the direction of faster sales or impending recession, these measures may make it seem as if a company has more cash or less cash than it really does. One reason is that the usual measures of cash flow-net income plus depreciation (NIPD) or earnings before interest and taxes (EBIT)-give a realistic indication of a company’s cash position only during a period of steady sales. It seems they have either too much cash or not enough.Īs a teacher and consultant, I have heard many executives explain how they get caught and why. Whatever the debates of academics, managers are-as always-caught. Still others are heretics or wedded to the ideas of the old church. I’ve written about it many times others have given cash flow the status of a new religion. In the end, you need to have enough money to pay your obligations or you’ll go out of business.Įmphasizing the importance of cash is not a new idea, of course. Those may sound like extreme statements, but time and again I’ve heard managers complain, “If I’m making such big profits, why don’t I have any money?” It doesn’t matter whether your industry is high tech or low, smokestack or service. You can’t pay bills with profits-only cash.
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