Importance of Cash Flow in Business Finance

This report explores the importance of cash flow in business finance, highlighting its role in working capital management. It discusses financial ratios as a tool for assessing company performance and compares profit and cash flow. The report concludes by emphasizing the significance of cash flow in business operations.

Business Finance

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
MAIN BODY ..................................................................................................................................1
PART 1............................................................................................................................................1
a. Explaining meaning and difference of Profit and Cash flow..................................................1
b. Stating the meaning of Woking Capital along with Receivables, Inventory and Payables....2
c. Changes in Working Capital affecting Cash flow...................................................................3
2. The way company managed affecting financial results..........................................................3
3. Steps taken to improve company's Cash Flow through better Working Capital Management.
.....................................................................................................................................................4
PART 2............................................................................................................................................5
1...................................................................................................................................................5
a. Elements of Financial Performance........................................................................................5
b. Ratio analysis..........................................................................................................................6
c. Ratio analysis interpretation....................................................................................................8
2. Assessing the financial performance of business....................................................................9
CONCLUSION................................................................................................................................9
REFERENCES..............................................................................................................................11

INTRODUCTION
Business Finance is a term which defines the process of employing and effective
utilization of money, funds and capital in the business organisation for achieving the set desired
goals and objectives in a cost effective manner thereby maximizing the profits. Every business
requires financial assistance for carrying on its business operations smoothly. Finance is
considered as the blood of every business organisation. Hence, in business unit, manager plays a
vital role in developing competent framework and thereby contributes in performance
enhancement. The report is based on UberTools Ltd, which is engaged in a business of
producing power tools. The present report will provide a deeper insight about the aspects of
Profit and Cash flow and how they differ from each other. Further, it also depicts the manner in
which Working Capital management influences the level of cash flow. Furthermore, the report
will explain about financial ratios and its uses for assessing the financial performance as well as
financial position of the business organisation in the context of Madagascar Industries Ltd.
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MAIN BODY
PART 1
1.
a. Explaining meaning and difference of Profit and Cash flow.
Profit also known by term Gain, is defined as the amount of money earned after making
all the payment and meeting cost expenses incurred from conducting a trade and business
activity during a specified period. It is used for measuring the success level of business
organisation in terms of profits earned
Cash Flow refers to the net amount of cash available with the company i.e. the difference
in cash amount which is available at the beginning of a period and at the end of the period
(Weber, 2018). It depicts the cash inflow and outflow that a business entity has during a period.
Cash flow of a company is based on three activities:
1. Operating Activities – It considers all activities which are carried on for conducting the
business operations and processes. It includes Net Income plus or minus the increase and
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decrease in the Current assets & liabilities and business expenses made for completing
operational activities (Weber, 2018).
2. Financing Activities – These activities of business is related to increase or decrease in
Long term debts, liabilities, owner's capital, repurchase of company's share or activity
related to issuance of dividends (Weber, 2018).
3. Investing Activities – This activity emphasizes on increase or decrease in the investment
made by the company either in fixed assets, long term investment etc (Weber, 2018).
The main difference between profit and cash flow of the business organisation is that Profit is
considered as the Net income or revenues as earned by the company after meeting all the
expenses of that period in a definite time period whereas the Cash flow calculates the net
increase or decrease in the cash opening and closing amount or helps in determining the change
in cash balance from period to period (Weber, 2018).
b. Stating the meaning of Woking Capital along with Receivables, Inventory and Payables.
Working Capital is defined as the amount of money which is required by the company for
meeting its day to day business operations. Net working capital is calculated by taking all the
current assets and current liabilities of the business. It helps in assessing and measuring the
operating efficiency, liquidity, profitability and financial health of the company (Samiloglu and
Akgün, 2016).
Receivables – Also known as Accounts Receivables is defined as the payment which company
has not yet received. It refers to payments which will be received by the company from its
customers on purchasing of its goods & services on credit basis which a short term ranging from
days to months.
Inventory – It represents the product which is owned by company. It also defines the plan of how
to use such inventory in carrying on production or operational process for next year. The
inventory of a business can be of nature such as raw materials, work in progress or finished
goods. In working capital calculation, inventory is considered as part of Current Assets
(Samiloglu and Akgün, 2016).
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Payables – This term refers to the obligations due on part of the company against the purchase of
goods on credit, to pay its short term debt or liabilities to its creditors, business suppliers with in
short period of time (Samiloglu and Akgün, 2016). Payables arises when company or any
individual purchases goods on credit rather than cash.
c. Changes in Working Capital affecting Cash flow.
Working Capital management ensures that the business should have enough liquidity to meet its
short term requirements and obligations, thereby ensuring that conducting business process is
profitable for both the stakeholders and for business organisation as well.
The change in working capital of the business has a great impact on Cash Flow of the company.
The more the cash is invested in working capital, it will result in increase in the working capital
also thereby reducing the cash flows. If the current assets and current liabilities are increased
with same amount, it will have no effect on the working capital and cash flow balance. On the
other hand, if a company makes a purchase of fixed asset with cash as payment, then it will lead
to decrease in cash flow as the company's current asset (in form of cash) is decreasing thereby
decreasing the working capital of the company (Singh, Kumar and Colombage, 2017).
2. The way company managed affecting financial results.
UberTools Ltd. Can manage its cash flow by focusing on increasing in the cash receivables
period and making delays in making payment i.e. delay in cash outflow. This helps in managing
the cash flow of company as the company is able to generate more cash which it can use for
making payments to its suppliers, creditors. By this, the company is able to improve its financial
position as well as financial performance as the level of profit will be increased thereby giving
benefits to stakeholders of the company (Epstein and et.al., 2015).
UberTools Ltd. Should also focus on effective inventory management system by adopting LIFO
and FIFO method. If the company is having high inventory with itself it depicts that company is
not able to convert its inventory into sales. On the other hand, if company is having low
inventory then there is a chance of losing profit. Proper valuation of inventory should be done to
assess the cost incurred in manufacturing and operating process (Epstein and et.al., 2015).
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3. Steps taken to improve company's Cash Flow through better Working Capital Management.
Working capital management is a strategy in which company ensures the effective and efficient
utilization of the two most important component of business organisation i.e. Current Assets and
Current Liabilities. The working capital management helps in ensuring better and smooth
functioning of business operations by generating liquidity and profitability on regular basis to
meet short term as well as day to day operations (Orobia, Padachi and Munene, 2016).
Cash flow depicts the inflow and outflow of cash in the business for a definite period. The cash
flow of a company can be improved by adopting the better management strategy for working
capital. The UberTools Ltd. Can adopt following steps for improving its cash flow:
1. Accelerating the inflows of Cash in the business – Every business organisation should
focus on increasing the cash inflow in the business. It represents the movement of cash
money into business as received by selling of goods or services to customers.
Accelerating the cash inflows helps in improving the overall cash flow by collecting cash
in quick and easy way. It will thus helps the business in paying bills, obligations on time
& can seek trade discounts advantage offered by suppliers on paying within certain
period (Orobia, Padachi and Munene, 2016).
2. Cash outflow to be delay for some time - Cash outflow is defined as the movement of
cash, funds or money amount out of the business organisation. Cash outflow can be
delayed for improving the cash flow position of the company by minimizing the expenses
related to production & other operating functions, purchasing new property or equipment
on credit period of long time or with the help of banking assistance etc (Orobia, Padachi
and Munene, 2016).
3. Minimizing Expenses – Cost expenses incurred in carrying on manufacturing and
operating activities of business should be minimized by improving the efficiency of
production units, operational capabilities. The expenses can be minimized by making
proper and effective business pans and strategies relating to repairing or updating
machines and plants instead of purchasing new property or equipment (Orobia, Padachi
and Munene, 2016).
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PART 2
1.
a. Elements of Financial Performance.
Sales growth: It shows the amount of increase in sales of the company's product and services
over a specific time period. For every company, growth in sales is considered as a positive factor
as it will lead to better survival in the competitive market, profitability (Epstein and et.al., 2015).
As the sales increases, the revenue will also increase which leads to more dividend amount
distribution for shareholders & rise in stock price.
Gross Profit Margin: It helps in assessing the financial position of the company. It measures the
amount of profit earn after meeting all direct expenses and expenses related to cost of goods sold
(Epstein and et.al., 2015).
Operating Profit Margin: It measures the amount of profit remains after meeting all the cost
expenses related to operating and manufacturing expenses. It helps in communicating the
profitability position of a company in conducting its business operations (Epstein and et.al.,
2015).
Gearing: It defines the value of debt and shareholder funds used by the company for financing
the assets of business organisation. It measures the proportion of a company's borrowed funds to
its equity (Epstein and et.al., 2015).
Interest Cover: It defines that the ability of a company in making interest payment i.e. how many
times it covers interest expense payment with its available funds.
Liquidity Ratio: It is used in measuring the ability of a company to pay off all its short-term
debts as well as financial obligations as they arise (Epstein and et.al., 2015).
Return on Equity: It measures that how effectively the company is using its fixed as well as
current assets for creating profits (Epstein and et.al., 2015). It shows the ability of company of
using its shareholders funds in maximizing the profit level.
Return on Capital Employed: It measures the company ability to generate profitability and
efficiency by using capital employed. It is considered as a profitability ratio which helps in
assessing a company's efficiency in generating profits from capital employed (Epstein and et.al.,
2015).
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b. Ratio analysis.
1. Sales Growth
Particulars Formula 2019 2020 2021
Sales 360 396 459
Sales growth Sales Y2 - sales
Y1)/sales Y1 10.00% 15.91%
2. Gross Profit Margin
Particulars Formula 2019 2020 2021
Gross profit 230 252 272
Sales 360 396 459
Gross Profit Margin GP / sales * 100 63.89% 63.64% 59.26%
3. Operating Profit Margin
Particulars Formula 2019 2020 2021
Operating profit 108 101 49
Sales 360 396 459
Operating Profit Margin OP /sales * 100 30.00% 25.51% 10.68%
4. Gearing
Particulars Formula 2019 2020 2021
Total Debt 0 0 37
Total Debt + Shareholders
Funds 304 347 381
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Gearing Total Debt/Total Debt +
Shareholder Funds (%) 0% 0% 10%
5. Interest Cover
Particulars Formula 2019 2020 2021
Operating profit 108 101 49
Finance Expense 9 12 16
Interest Cover
Operating
Profit/Finance
Expense
12 8.42 3.06
6. Liquidity Ratio
Particulars Formula 2019 2020 2021
Current Assets 65 114 94
Current Liabilities 29 48 102
Liquidity Ratio Current Assets / Current Liabilities 2.24 2.38 0.92
7. Return on Equity
Particulars Formula 2019 2020 2021
Net profit 79 72 26
Shareholders Funds 304 347 344
Return on Equity Net Profit/Shareholders
Funds * 100 26% 21% 8%
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8. Return on Capital Employed
Particulars Formula 2019 2020 2021
Operating profit 108 101 49
Total Debt + Shareholders
Funds 304 347 381
Return on Capital
Employed
Operating Profit/(Total
Debt + Shareholder
Funds)*100
36% 29% 13%
c. Ratio analysis interpretation.
1. Sales Growth – The sales growth depicts the increases in sales of a company during a
specified period of time. Here, the sale of Madagascar Industries Ltd. Is increasing from
10% to 15.91% which shows that customer are highly satisfied with services and
products therefore are purchasing and consuming more products and services of the
company which helps the company in increasing its profits level (Epstein and et.al.,
2015).
2. Gross Profit Margin – The gross profit of Madagascar Industries Ltd. Is declining from
63.89% to 59.26% in last three years which is not a good sign for company's growth. The
company should focus on minimizing the Direct Expenses incurred by making effective
and better business plans and strategies.
3. Operating Profit Margin - The operating profit of Madagascar Industries Ltd. Is declining
from 30.00% to 10.68% in last three years because of increasing operating expenses of
company which is affecting the company's growth (Epstein and et.al., 2015). The
company should focus on minimizing the Direct Expenses incurred by making effective
and better business plans and strategies.
4. Gearing – It defines the value of debt and shareholder funds used by the company for
financing the assets of business organisation. The debt equity ratio of Madagascar
Industries Ltd. Is increasing by ten times in last three years which shows that company
can suffer a financial risk in coming year if it continues to increase.
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5. Interest Cover - This ratio determines company ability to make payment related to
interest expenses on debt on time. The interest cover of Madagascar Industries Ltd. Is
decreasing every year which means that the company is having a high burden of making
payment related to debt expense (Epstein and et.al., 2015).
6. Liquidity Ratio – It helps in determining the short-term financial position of business i.e.
the ability of a company to meets its current as well as future financial obligations. The
company Madagascar Industries Ltd. attains a ratio of 0.92 from 2.24 which means that
company is not having idle cash fund with itself and is able to pay off all its liquid
liabilities.
7. Return on Equity – It shows the ability of company of using its shareholders funds in
generating profits. It measures that how effectively company’s assets is used for creating
profits. The return on equity of the company Madagascar Industries Ltd. Is declining on
continuous basis from 26% to 8% which can be improved by acquiring high level of debt
(Epstein and et.al., 2015).
8. Return on Capital Employed – It measures the company ability to generate profitability
and efficiency by using capital employed. This ratio of Madagascar Industries Ltd. Is
decreasing from 36% to 13% which can be improved by maintaining operating profit at
high level and reducing the capital employed value.
2. Assessing the financial performance of business.
The financial performance of a business can be asses by:
1. Budgetary plans – A company by making estimated budgets for meeting future cost expenses
and profit levels can achieve its set desired goals as well as objectives effectively and on time
(Epstein and et.al., 2015). With the help of budgetary tools the company can also assess its
performance and makes improvement in quality and performance.
2. Formulating business strategy – By formulating business plans and strategies for business, the
company can achieve its goals easily. By implementing and monitoring theses business strategies
and plans from time to time, business can achieve its objectives and growth factor.
3. Increase Operating efficiency and capabilities – The company can achieve maximum profits
by reducing the expenses related to cost of goods sold, labour costs, operating cost (Epstein and
et.al., 2015).
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CONCLUSION
From the above report it can be concluded that, business finance is a term which defines the
importance of monetary value, funds and cash in the functioning of business operations. The
report has discussed that how a company can improve its cash flow by adopting measures of
working capital management. This report has shown the importance of financial ratios in
assessing the financial position as well as performance of the company. Further, the report has
defined the meaning of profit and cash flow and how they differ.
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REFERENCES
Books and Journals
Aktas, N., Croci, E. and Petmezas, D., 2015. Is working capital management value-enhancing?
Evidence from firm performance and investments. Journal of Corporate Finance. 30. pp.98-
113.
Epstein, M.J., and et.al., 2015. Managing social, environmental and financial performance
simultaneously. Long range planning. 48(1). pp.35-45.
Kajola, S. O., Olayiwola, P.O. and Ekpudu, J.E., 2018. Working Capital Management Practices
and Profitability in Nigeria. Izvestiya. (3-4). pp.200-218.
Muhammad, H., Rehman, A. U. and Waqas, M., 2016. The Relationship between Working
Capital Management and Profitability: A Case Study of Tobacco Industry of Pakistan. The
Journal of Asian Finance, Economics and Business (JAFEB). 3(2). pp.13-20.
Orobia, L. A., Padachi, K. and Munene, J. C., 2016. Why some small businesses ignore austere
working capital management routines. Journal of Accounting in Emerging Economies. 6(2).
pp.94-110.
Pais, M. A. and Gama, P. M., 2015. Working capital management and SMEs profitability:
Portuguese evidence. International Journal of Managerial Finance. 11(3). pp.341-358.
Samiloglu, F. and Akgün, A.İ., 2016. The relationship between working capital management and
profitability: Evidence from Turkey. Business and Economics Research Journal. 7(2). p.1.
Singh, H. P., Kumar, S. and Colombage, S., 2017. Working capital management and firm
profitability: a meta-analysis. Qualitative Research in Financial Markets. 9(1). pp.34-47.
Weber, M., 2018. Cash flow duration and the term structure of equity returns. Journal of
Financial Economics. 128(3). pp.486-503.
Online
Definition of 'Cash Flow'. 2019. [Online]. Available through:
<https://economictimes.indiatimes.com/definition/cash-flow>.
Financial Ratios. 2019. [Online]. Available through:
<https://www.accountingcoach.com/financial-ratios/explanation/2>.