The Cash Flow of ABC Limited - Essay Example

The Cash Flow of ABC Limited Business Report – ABC This business report focuses on the performance of the company, ABC Limited. The performance is analysed using the cash flow statement for the year ending on 31.12.2007. This indicates the usefulness of cash flow in analysing a company’s performance in addition to the information that can be obtained from the balance sheet and profit and loss statements. The cash flow statement provides valuable information on the quality of income and sales, dividend and interest covers, the cash available per share and the cash returns generated by the assets. These are discussed in the following sections. Quality of Income: In addition to the quick ratio or current ratio (Monetary Assets / Current Liabilities) and the liquidity ratio (Current Assets / Current Liabilities), another very useful ratio to analyses a company’s performance is the quality of income (Net Cash Inflow from Operations/ Net Profit before Interest and Tax). The quality of income ratio helps understand the company’s income a little better. The net cash inflow for ABC Limited is £155 and the Profits before interest and tax totals to £67, thus making its Quality of Income Ratio as 2.313. Cash Flow Statement for ABC: Notes £ £ Operating profit 67 Depreciation for 2007 60 Loss on disposal of fixed assets 3 Changes in stocks / inventories 14 Changes in debtors / receivables 6 Changes in creditors / payables 5 88 Net cash flow from operating activities 155 Taxation paid this year (15) Investing activities Payments to acquire fixed assets (115) Receipts from sale of fixed assets 2 (98) Financing activities Issue of shares / stock 50 Repayment of loan (30) Dividends paid this year (6) 14 Change in cash over the year 41 (between the Balance Sheets) Capital Expenditure Ratio: This ratio helps analyse the amount of free cash that has been utilised to increase the capital expenditure. It computed as: Retained Cash Flow (After Div. Paid) / Cash Paid for Acquisition. For the case of ABC Limited, the amount of money that has been invested to capital expenditures is £ 115 and the total amount of free cash is £134 (i.e. Net cash from Operating Activities less the tax paid less the dividends paid = 155 - 15 – 6). Thus the capital expenditure ratio totals to 1.165%. It is clear that ABC limited has invested a high amount in capital expenditures and still there is a net increase in cash, indicating that the company has performed very well in terms of collecting the cash from the customers. Cash Dividend Cover: The Cash Dividend cover focuses on the available cash (after the tax and interest is paid), divided by the total ordinary Dividend. It can be calculated using the following formula Cash Dividend Cover = Net Cash Flow from Operating Activities – Tax Paid – Interest Paid Total Ordinary Dividend In the case of ABC limited, the cash dividend cover equals 23.33x. This figure signifies that the ABC limited has generated cash which is about 23 times the dividend that has to be paid. Cash ‘Owing’ Coverage: The cash owing cover signifies the total amount of free cash (i.e. Net Cash income from operations less the tax, less interest and less dividends) that is used to settle the total owing of the company. Calculation of the cash owing cover can be done by dividing the total owing by the retained cash from operations (after dividend). ABC Limited has a total owing of £72 m and the net free cash after dividends totals to £134 m (155 – 15 – 6) thus making the cash owing cover to total to 0.537. Therefore the number of years to pay off debt is 0.5years or 6 months. This indicates that ABC limited can pay off the debts in a very short period. Cash Flow per Share: This signifies the amount of money that is paid to the shareholders per share. It is simply calculated by dividing the total available cash to the ordinary shareholders by the average number of shares. The answer signifies the total amount paid per share. Calculating the amount that ABC limited pays out per share: Cash Flow per Share = (155 – 15)/150 = 140/150 =£0.93 per share This signifies that the company has the cash to pay to pay up to £ 0.93 to each of the ordinary shareholders. Cash Return on Average Capital Employed: This signifies the total amount of cash that has been utilised for useful capital expenditures. It can be calculated using: Net operating cash flow before interest and tax / Average capital employed. The amount that is invested in the company from the net earnings from operations forms the average capital employed. The more capital employed signifies the company is performing well. In the case of ABC limited the cash on average capital employed: = 155/ ½ (190 + 110) = 1.033 Cash Return on Average Total Assets: This signifies the total amount of cash that has been utilised for assets. It can be calculated using: Net operating cash flow before interest and tax / Average total assets. The amount that is invested in the assets by the company from the net earnings from operations forms the average total assets. The more the total assets signify the company is performing well. In the case of ABC limited the cash on Total assets: 155 / ½ (200 +150) = 0.855 Conclusion: While the balance sheet and the profit and loss statements can provide valuable information on the profitability, efficiency and gearing of the company, Cash flow provides additional information on the company’s liquidity in terms of net cash change. The analysis based on Cash flow statement is equally important, as a company might be performing very well in terms of profitability, but might face a number of issues in terms of liquidity, i.e., free cash available to spend on capital investments and dividends might be very low. The free cash ratios, namely capital acquisition cover, cash dividend cover and total owing cover provide valuable info to the investors in the company. In the case of ABC limited, these figures are substantial indicating that the company is strongly positioned to meet its needs in the short term with the cash available in hand. The quality of income for ABC is above 2x, indicating that the cash generated from its operations is more than twice the net profits. It is evident that ABC has an efficient cash operating cycle and is able to collect the cash owed very effectively. The cash return on average capital employed and the average total assets, indicate the effectiveness of the assets utilised in generating cash for ABC. These values, in addition to the asset turnover ratio provide valuable information on the utilization of the assets in the business. Thus cash flow analysis for ABC limited indicates that the company is very strongly positioned in terms of generating cash from operations and it is effectively used in the capital and other expenses. Read More