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Cash Flows and Business
Introduction to Finance (FIN2303)
Algonquin College
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Cash Flows and Business
Cash Flows
Cash is the lifeblood of every company. Without sufficient cash flows, a company cannot pay its employees, buy materials and supplies, and ultimately, remain in business. Many corporate bankruptcies resulted from a lack of cash flow, as opposed to a lack of revenues. Remember than revenue is making money, cash flow results from collecting money.
We start our cash flow analysis with the following cash flow identity:
Cash flow from assets = Cash flow to bondholders + Cash flow to shareholders
We can also calculate cash flow from assets another way:
Cash flow from assets = Operating cash flow – Net capital spending – Changes in net working capital
Sources and Uses of Cash
Understanding cash flows and the cash flow identity requires that we can classify each transaction as a source or use of cash.
Assets Liabilities & Owner’s Equity
Increase = USE of cash Increase = SOURCE of cash
Decrease = SOURCE of cash Decrease = USE of cash
As an example, if we buy inventory, our inventory increases and this is a use of cash, since we paid for the inventory using cash and this payment decreased our bank account balance. If we issue new debt (bonds) this increases our liabilities and is a source of cash, represented by the cash received from our new bondholders. The cash flow effect on Accounts Payable (“AP”) can be confusing, but consider this; if you buy something and pay cash, this is clearly a use of cash, since your bank account balance goes down when you pay. But, if you buy something and pay on credit (an increase in AP); this is a source of cash, since you aren’t using your cash to pay for the goods received. Eventually, you will pay for these goods and reduce your AP balance. The payment is a use of cash, since you have to issue a cheque to pay for the goods.
Cash flows are classified as operating, investing, or financing activities on the statement of cash flows, depending on the nature of the transaction.
Q: What do you call it when a company either earns or spends money?
A: Operating Activities
The following are some examples of operating activities a business would perform
● Cash received from customers ● Cash paid to vendors and or employees ● Interest earned ● Interest paid
Q: What do you call it when a business contributes something with a monetary value to the business?
A: Investing Activities
The following are some examples of investing activities a business would perform
Purchase of investments (stocks or bonds)
Proceeds from the sale of investments (selling of stocks or bonds)
● Purchase of Property, plant, and equipment (long term assets) ● Proceeds from the sale of long term assets
What do you call the process of acquiring capital to fund a start-up, an expansion, or basic operations?
A: Financing Activities
The following are some examples of financing activities a business would perform
● Sale of securities- when a company sells its own stock it is considered a financing activity. ● Dividend payments- when a company makes money it must give some money back to its stockholders ● Loans Received-accepting a cash loan then translates as an increase in cash from financing activity. ● Loans Collected: Payback of money borrowed from banks
Operating Activities (activities related to income)
Cash receipts from the following:
Cash Flows and Business
Course: Introduction to Finance (FIN2303)
University: Algonquin College
