Business finance

Report to the shareholders

I) Explanations

a) Profit and Cash Flows and how they are different

Profits

Profits of a company describes financial benefits realized when revenues generated from business activities exceeds costs, expenses and taxes that are involved in sustaining activity. Profits earned by the business funnel back to its owners , who have the choice of using this profit for their own benefits or to reinvest back into business. Profits are calculated as total revenues less total expense. Profits refers to the money pulled by the business after all the expenses have been accounted. Be it a sole proprietary business or a multinational company, the primary goal of every business is to earn money; therefore, the performance of the business is measured based on its profitability. Profits are of three types: gross profits, operating profits and net profits, and all of these are shown in income statement of company (Williams and Dobelman, J.A., 2017). Every profit gives different type of information that are used by the analysts according to their needs.

Cash Flow

Cash flow refers to the amount of net cash & cash equivalent that are being transferred in and out of business. At basic, fundamental level, cash flows determine the ability of company to generate positive cash flows and create values for its shareholders. It is also aimed at maximising the long-term cash flows. Assessing amounts, timings and uncertainty in cash flows is also the objective of financial reporting. For assessing the flexibility, liquidity and financial performance of the company it is essential to have an understanding of the cash flows (Miao, Teoh and Zhu, 2016). Cash flows are important for recognising whether the company is utilising the cash funds in an efficient manner or not.

Difference in Cash flows and the profits

Profit and cash flows are separate financial parameters, and both are to be considered when running business for keeping the track record. Companies are required to report over both profits and cash holdings. Profit is accounting that is not measurable in cash inflow or outflow.

Operating Cash Flows

It is outcome of cash activities in business operation regardless of whether cash transactions are generating earned revenues or incurred expenses at time of transaction. For instance, when advance payments are received from customers, it will increase the cash holdings of the company but no effect would be seen on its reported profit (Sri, 2017).

Non Operating Cash Flows

Few cash flows may not be the outcome of operating activities of the company and may not be related to the profitability. Along with operating activities, cash flow from financing and investing activities is also reported by the company. When investments are sold or funds are obtained from financing , cash positions are increased, but they are not added to the revenues. Similarly, the purchase of fixed assets will decrease the cash positions but the profits will not be harmed. Heavy purchases can result in negative cash flows even when the company is showing good profits (Gordon et al., 2017).

Non-Cash Revenues

Non-cash revenues are the profit arising on sale of fixed assets, or the company recording accrued profits; this will increase the profits but cause no change in the cash holdings.

Non-cash expenses

They decrease the profitability of the company but no impact is seen in cash holdings as they do not result in any cash outflows like depreciation.

There are situation where company may show profits but do not have enough cash to meet the daily expenses. This may result in the break down of company operations. This sometimes cause the company to liquidate due to the nonavailability of cash.

b)Working Capital

Working Capital refers to difference between current asset like accounts receivable, cash and inventories and current liabilities like accounts payable. Working capital measures operational efficiency, liquidity and short-term financial health of the organisation. A company with positive working capital have the potential to invest and grow. If the current assets are not exceeding current liabilities, company might face trouble in paying back to creditors or growing; it may even go bankrupt (Kopita, Charitou and Karamanou, 2017).

Receivables: It refers to the amount due from customers to whom goods have been sold on credit.

Inventory refers to the stock of goods manufactured or traded by company. Inventory could be of raw materials or the finished goods. Inventory of the company are current assets of company.

Trade Payable: Like receivables, payables are the amount due to the supplier of the raw materials from whom company have taken goods on credit. These are shown under head current liabilities.

c) Effects of working capital on cash flows

Increases in working capital show that more cash is being invested in the working capital, thereby reducing the cash flows. Those companies having significant requirements of working capital find that the working capital also grows and this would be reducing the cash flows of company. There is a relationship between cash flows and the working capital; companies that efficiently manage their working capital have high value as compared with firms having high working capital requirements (Girish and Desai, 2017).

II) Analysis of Cash Flow statements

Analyzing the cash flow statement of the company, it could be said that the company is not efficiently managing its cash flows. The operating profit of the company is just $5 million, that is 10% of the total turnover. The debts of the company have increased by $2 million, that will increase inflows in financing activities. Cash flows of $10 million will be considered in investing activities where the $8 million advance will be increase the working capital. The company has current liability of $1.5 million, but this will not affect the cash flows of company. Cash flows of the company will show positive results. The contingent liability of $2 million will affect the cash flows. But the increase in cash flows will not be increasing the profitability of company. Therefore, it is essential to effectively manage the cash flows and working capital of the company (Ketz, 2016).

III) Steps to be taken for improving the cash flows by working capital management.

Working capital means amount through which current asset of company exceed the current liabilities. Cash flows of the company could be improved by effectively managing the working capital of company. Here the company is growing at constant pace with sufficient profits, and the company may also face negative cash flows. Therefore, it is essential for company to manage properly its c