Understanding Cash Flow Statements and Financial Ratios, Apuntes de Administración de Sistemas y Redes

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Cash Flow Statement

& Ratios

What is CFS (Cash flow statement)?

While the balance sheet of the company can tell you what the cash and cash equivalents balance at the beginning of the period and the end of the period were, it cannot tell me how the company generated or consumed the cash. It is the cash flow statement that tells you how the company generated or consumed its cash and cash equivalents.

Analysis

• cash flow from operating activities represents the difference between the cash received from customers and the cash paid out for operating expenses. It tells how everyday operations affect the amount of cash on hand.
• Investing activities can include cash inflows and outflows resulting from:
• The purchase or sale of an asset (like computer equipment or office space).
• Acquiring or merging with another company.
• Dividends earned from ownership of stock in another company.
• financing activities - deals with cash involved with borrowing, repaying, or raising capital. This is where investments others have made in your business are recorded, and that may include:
• Receipt of venture capital or other funding
• Bank loans — both the receipt of funding (cash inflow) and repayment of the loan (cash outflow)
• Company shares sold
• Dividends paid to shareholders.

Financial performance ratios Financial performance ratios define specific measures that reflect the financial information in a comparable format, to identify the main trends and to formulate the questions properly. Financial performance ratios are measures that reflect the financial information in a comparable format, to identify the main trends and to formulate the questions properly. Financial ratios can be subdivided into the following groups:

• Capital structure and financial stability ratios;
• Liquidity ratios;
• Profitability ratios;
• Enterprise asset turnover ratios;
• Investment ratios.

5.6.1.1. Percentage of liabilities in the balance sheet (K 2 ) shows the percentage of borrowed assets in the total capital. The lower this indicator is, the more willingly the creditors will issue a loan. At the standard level this indicator lies between 0.4-0.8. K 2 = total liabilities / total assets K 2 = 1 - K 5.6.1.1. The relationship of liabilities to equity or the financial leverage (K 3 ), describes the dependence of the enterprise on external borrowings. A high value of this indicator suggests that the enterprise uses a lot of external capital. 0.5 < K 3 < 1 K 3 = total debt / shareholders ’ equity

Working capital Working capital = current assets – current liabilities The working capital tells us the short-term, liquid assets remaining after short-term liabilities have been paid off. It is a measure of a company’s short-term liquidity and important for performing financial analysis, financial modeling, and managing cash flow.

The working capital provision ratio (K5) shows the proportion of current assets covered by own resources, for which there is no need to raise assets from outside. K5 = working capital /current assets The higher this value is (up to 0.5) the higher the potential for the enterprise to carry out an independent policy.

Liquidity ratios. This type of analysis helps to evaluate the enterprise solvency and provides with the conclusion as to the maintenance of the financial balance and solvency in the future Current ratio (Li) is the ratio of current assets to current liabilities. The value of this ratio ranges between 1 and 2. Li = current assets / current liabilities If this ratio is below 1, the enterprise is in a critical financial position , it is operating high risk conditions. If current assets are above current liabilities the enterprise may be considered as a successfully functioning entity. Current ratio shows the value in excess in relative terms. The value of this ratio may considerably differ by area of activity and type of operations, but its reasonable increase is usually considered as a favourable trend. The rate usually applied in practice is 1 - 2 , but it is only an approximate value. If the ratio is too high (>3), this indicates that there is a possible asset management problem in the enterprise and that the working capital is not efficiently used.

Return on sales (ROS) (R1) is the relation between the financial amount figure and the volume figure, or - how much profit is made on each unit of net turnover. R1; (ROS) = (net profit for the reporting period / net turnover) * This indicator is affected by the operating results, the pricing policy of the enterprise and the operating cost efficiency.

Operating profitability ratio (R2) is a measure only affected by the operating performance results, the pricing policy of the enterprise and the operating cost efficiency. R2 = (profit before interest and tax /net turnover) * Profit before tax does not include revenues and costs which are neither associated with the production of output nor sales and the provision of services. This ratio is used to measure the efficiency of production and sales in gaining of income.

Return on equity (ROE) allows to determine the efficiency of use of the capital invested by the enterprise owners and to compare this value to potential of generating income by investing these assets in other securities. This is the most significant measure from the owner’s point of view: it shows, how much profit has been made per each currency unit (dollar, euro, zloty) invested in the enterprise by the owner. ROE = (annual profit /weighted average amount of equity) * 100