Cash Flow Management in Organizations - Essay Example

Cash Flows in Business Organizations of Contents Contents 2 Introduction 3 2 Task Total 14 marks)- Net Profit generated by operations and Cash Generated by Operations, why not equal? 3 2.3 Task 3 (Total 60 marks) Comparison of Gazprom and Surgutneftgas 5 7 3. Conclusion 7 4. References 7 5. Appendices 8 1. Introduction Task I seeks to explain to concerned business owner about the possible reasons for the different between Net Profit generated from operations to the Cash generated by operations over the same period, using a hypothetical example to support the same. Task 2 seeks to explain the difference between the direct and indirect methods, of presenting Operating cash flow section of the Cash Flow Statement, including the layout of each. Task 3 will compare and contrast how Surgutneftgas and Gazprom, as public limited companies, in the same industry for the years 2011 and 2012 as to their respective cash flows from their operating activities. In addition, it will explain how the companies have managed their working capital for the accounting periods. This will further analyse and explain the financing activities of the two companies. Task 4 will comment on the overall strategy being observed by the two companies based on their cash inflows and outflows based on analysis made on earlier tasks. A determination of which was able to manage its cash better will be made with reasons. 2.1 Task 1 (Total 14 marks)- Net Profit generated by operations and Cash Generated by Operations, why not equal? The net profit generated from operations by the business may not be equal to the cash generated by operations by the same period because net profit includes non-cash items recognized as income and expenses but they do not necessarily involve cash. The reason for this is that revenues and expenses in the income statement are generally prepared under the accrual method of accounting (Kieso et, al, 2007) while Net Cash from operations, has taken this fact in consideration and this is the reason that certain items are added and subtracted to the net profit to arrive at the operating cash flow from operations. Thus there is need to add back to the net income, prepared under the accrual method, the non-cash deductions like amortizations and depreciations expenses. There is also need to deduct non-cash revenues like gains on sale of properties and investments and other adjustments. To illustrate, an example of the adjustments to the net income is shown in appendix A. Note that the net profit of $200,000 is lower than the net cash from operations of P246,700. An adjustment amounting $46,700 basically included added back depreciation, subtracted gains from sales and/or revaluation and change in working capital. 2.2 Task 2 (Total 6 marks). Difference between Direct Method and Indirect Method of presenting Operating Cash Flow section of the Cash Flow Statements The direct method of presenting the operating cash flow section just have the result of cash flow from operations appear without reconciling with net income when presented in the Cash Flow Statement. But said cash flow from operations was actually computed based on accounts from the income statement and balance sheets. Under this method (net) cash flows from operating activities come from cash receipts from sales. There is need to add interest and dividends and to deduct cash payments operating expenses, purchases of inventory and interest and income taxes. This is illustrated in Appendix B. On the other hand, the indirect method reconciles net income with net cash flow from operations in the Cash Flow statement by adding back non-cash expenses and deducting non-cash gains. This is illustrated in Appendix A as used in Task 1 earlier. 2.3 Task 3 (Total 60 marks) Comparison of Gazprom and Surgutneftgas 2.3a. Compare and contrast their net cash flows from Operating Activities of the two companies for the years and 2012. (16 marks) The cash flows from operating activities of two companies are both positive or there net cash flows with 248,920 for Gazprom and 1,695,509 Russian rubles for Surgutneftgas as shown in Appendix C. But in absolute figures, Gazprom has higher net cash from operating activities than Surgutneftgas, which basically came from net profit from operations. Both have positive net profits for two years but Gazprom is higher in absolute figures. Both experienced also decrease in net profit and in net operating activities. The net adjustment for non-cash items was negative for both years in the case of Gazprom but in the case of Surgutneftgas it was only negative in 2012. Note however, the negative net adjustments are added while positive one is deducted. Both companies experienced decrease in net working capital for two years but the decrease for Gazprom was lower compared to Surgutneftgas. See Appendix C. 2.3b. Explain how each company has managed its working capital over the two accounting periods? (18 marks) As to how each company has managed its working capital over the two accounting periods, it appears that both of them showed decrease in their net change in working capital. The decrease for Surgutneftgas was higher than Gazprom despite the former’s lower operating cash flows from operating activities. But since both were able to maintain positive net operating cash flows for both periods, it can be deduced that both managed well their working capital but Gazprom can be declared slightly better because of the lower decrease in working capital given already the higher cash flow from operations. Please refer to Appendices C, C-2 and C-3. 2.3c. Based on their financing activities, which of the two companies faces lower risk for their long-term funding policy in the most recent year? (14 marks) Gazprom faces lower risk for its long-term funding policy in the most recent year than Surgutneftgas because, it has higher net cash flow from operating activities as support for both years, Although in 2012, both companies indicated cash outflows from financing activities, based on 2011 figure Gazprom was able to realize net cash inflow as against two cash outflows from Surgutneftgas. Negative cash flow or outflow for financing activities indicates lack of balance and cash from operation must be enough to cover the requirement in the meantime. See Appendix C. See Appendices C-2 and C-3. 2.3d. Based on their financing activities, which of the two companies has a more prudent investment policy in the most recent financial year? (12 marks) As to which of the two has a more prudent investment policy in the most recent financial year, it is asserted that it should be Gazprom considering that the ratio of net cash operating activities in relation to net cash flow operating activities in 2012 as the most recent year is only -75% as against -78% of the other company. See Appendix C-1. Prudence in investment in this context is meant, investing less with cash given the other requirements of the business while remaining liquid. See Appendices C-2 and C-3. 2.4 Task 4 (10 marks)- Comment on the overall strategy based on previous analysis. Which of the managed its cash flow better? Explain. The company which was able to have a more prudent investment policy and faces lower risk its long-term funding policy, is the one which was able to manage its cash flows better. As found earlier, Gazprom must be declared to be the better manager. Companies through their management are continuously managing risk in relation to the finance function of wealth maximization (Brigham and Ehrhardt, 2010). Minimizing the risk is actually maximizing wealth as this has the effect of minimizing cost of capital which is used for discounting future cash flows on the business. 3. Conclusion ` It can be concluded that to understand the liquidity and solvency of a firm, reliance be extended beyond the balance sheet and income statement as the only part of the financial statements. The cash flow statement is also a material part of financial statements and by extracting relevant information from the latter, there is much to know as a way of validating if not correcting those found from the traditional ratios. As found in the companies, this paper was able declare that Gazprom was managing better its cash flow from operations, and also its financing activities and investing activities. 4. References Brigham, E. & M. Ehrhardt (2010). Financial Management: Theory and Practice. Cengage Learning Kieso, et al (2007). Intermediate Accounting. John Wiley and Sons Gazprom (2014). Financial Statements for 2012. Retrieved 15 February 2014 from < http://www.gazprom.com/f/posts/01/207595/gazprom-ifrs-12m-2012-en.pdf > Surgutneftgas (2014) Financial Statements for 2012. Retrieved 15 February 2014 from < http://www.surgutneftegas.ru/uploaded/IFRS(1).pdf > 5. Appendices Appendix C-2- Surgutneftegas – Changes in Cash Flow Appendix C-3 – Gazprom –Change in Cash Flow Appendix D-1 ; Source (Surgutneftgas, 2014) Appendix D-2; Source: (Gazprom, 2014) Appendix D-3; Source: (Gazprom, 2014) Read More