Cash Flows in Business Organizations - Assignment Example

Cash Flows in Business Organizations Cash Flows in Business Organizations Task Cash generated vs. Net profit generated Cash generated from operations is significant in the sense that it shows whether a firm has the capacity to generate enough optimistic cash flow to sustain and expand on its operations or if the company will or will not require external financing (Epstein & Jermakowicz, 2007; p. 91). Cash generated from the operations is determined by making adjustment to the net profit for transactions such as variations in the accounts receivable, depreciation and changes in inventory. Therefore in the same period net profit cannot be equal to the cash generated from operations given that both variables are derived and applied separately. There are certain accounting effects that might be put into consideration when looking on a cash flow which will offer a clear reality of the business operations. For example, with cash flow statement there is use of cash sales while income statement where net profit is derived there is use of credit sales (Barry, Eva and Jermakowicz, 2007; P. 93). Booking a huge volume of sales will give a huge enhancement to revenue, even though in case the firm is experiencing difficult times in collecting cash, then it might not be a true economic gain for the firm. On the contrary, the organization might be extremely profitable on the basis of cash flows but might be experience reduced net profit, in case it has plenty of non-current assets and applies calculation of depreciation based on accelerated depreciation. The following is an illustration of a cash flow statement and the determination of cash generated. Cash flow statement for ABC Company (Direct method) Cash flows from (used in) operating activities Amount in million £ Amount in million £ Cash receipts from customers 19,000 Cash paid to suppliers and employees (4,000) Cash generated from operations (sum) 15,000 Interest paid (4,000) Income taxes paid (6,000) Net cash flows from operating activities 5,000 Cash flows from (used in) investing activities Proceeds from the sale of equipment 15,000 Dividends received 6,000 Net cash flows from investing activities 21,000 Cash flows from (used in) financing activities Dividends paid (5,000) Net cash flows used in financing activities (5,000) Net increase in cash and cash equivalents 21,000 Cash and cash equivalents, beginning of year 2,000 Cash and cash equivalents, end of year 22,000 Source: (Helfert, 2001; p. 42) Task 2 According to the International Accounting Standard number 7 the statement must be presented in direct method and indirect method in presenting the operating cash flow. Direct method of presenting operating cash flow depicts every main category of cash receipt and cash payment. This would appear as follows: Cash flows from (used in) operating activities Amount in million £ Amount in million £ Cash receipts from customers XX Cash paid to suppliers and employees XX Cash generated from operations (sum) XXX Interest paid XX Income taxes paid XX Net cash flows from operating activities XXX Source: (Helfert, 2001; p. 42) The indirect method on the other hand makes adjustments on the loss or net income on accrual terms for the impact of the non-cash items. The operating cash flow part using the indirect method would appear as follows; Profit before interest and income taxes XXX Add back depreciation XXX Add back amortization of goodwill XXX Increase in receivables XXX Decrease in inventories XXX Increase in trade payables XXX Interest expense XX Less Interest accrued but not yet paid XX Interest paid XXX Income taxes paid XXX Net cash from operating activities XXX Source: (Helfert, 2001; p. 42) Task 3: Analysis of Cash flow Statement of Barclays Banking Group and HSBC bank Question 3 a) Assessment of net cash flows from operating activities Barclays bank realized net cash flows from operating activities of £ 10.868 billion in 2013 and (£ 44.753) billion in 2012. The tremendous increase in the cash flow from the operating activities was attributed to a high percentage change in the operating assets and liabilities from 2012 to 2013. Barclays bank in this case seems to have improved in the approach used to manage the assets and liabilities. Moreover it is also clear from the cash flow statement that Barclays bank experienced a sharp decrease in the adjustment for non-cash transactions. The corporate tax paid also increased from £ 627 million in 2012 to £ 794 million in 2013 (Barclays Banking Group 2014; p. 17). This might be attributed to the increase in profitability of the firm which increased the amount of taxation. This is evident from the cash flow statement as the company improved its profit level from £ 74 million loss in June 2012 to a net profit of £ 1.677 billion. On the other hand, HSBC bank recorded net cash flows from operating activities of £ 51.339 million in 2013 and £ 258.354 million in 2012. Contrary to Barclays bank, HSBC recorded a reduction in net cash flow from operating activities which is attributed largely from the reduction in the collections from treasury bills. The highest amount was collected from interest, commission and claims receipts in 2013 even though this is a decrease from the previous year’s results. The amount reduced £ 264.547 million to £ 256.793 million that was recorded in 2013. HSBC had the least collections from financial assets designated at fair value despite being more than the previous year’s outcome. When put to comparison, the two baking institutions, in spite of realizing profits from their operations, Barclays bank seem to be performing better than HSBC due to its magnitude and volume of assets (HSBC Stock Exchange Announcement, 2014; p. 10). Question 3 b) Management of working capital over the accounting periods Working capital refers to the balance between the current assets and current liabilities. The difference might be negative or positive depending on how the company manages and controls the use of its current assets and liabilities (Paul, 2007; p. 631). Notably, a company with negative working capital demonstrates that the management has failed in its responsibility to effectively manage the short term assets and liabilities hence the company might be at risk in terms of fulfilling its short term obligations. In reference to Barclays bank the institution has current assets of about £1.4 billion in 2013 and current liabilities of £1.3 billion. Notably, calculating the difference between this figures shows that the company recorded positive working capital for the fiscal period 2013. In 2012 Barclays bank had current assets of about £ 1.2 billion where as the current liabilities £1.1 billion hence the working capital was about £ 100 million (Barclays Banking Group 2014; p. 17). It can therefore be concluded that Barclays bank has the ability to meet its short term obligation from the available short term assets. Liquidity risk available is therefore very minimal. On the other hand the current assets for HSBC bank in 2013 ware £ 4.42 billion and the current liabilities in the same period were approximately £ 4.0 billion. Similarly the company recorded a positive working capital which shows the ability to meet its short term obligation with the available liquid assets. In 2012, HSBC bank has current assets approximating to £ 5 billion and current liabilities amounting to £ 4.5 billion which reveals a working capital of about £ 0.5 billion (HSBC Stock Exchange Announcement, 2014; p. 10). As a result, the company can be said to be confident in relation to the management of current obligations. From the two analyses it is clear that both banks have done a great job in management of current assets and liabilities. Therefore, the vulnerability to liquidity risks for the two banking institutions is very low. This can also be determined or deducted from the determination of the current ratios where a ratio of more than 1 shows the company’s stability in managing current liabilities from the current assets. Question 3 c) Financing activities of the two banking institutions Barclays bank has most of its financing activities focused on selling of shares or stocks to the general pubic at the London stock exchange. Notably the company financed the selling of shares where the management committed to pay £ 1.212 billion of dividends in the year 2013 while the year 2012 saw the management received dividends of up to £ 3.861 billion (Barclays Banking Group 2014; p. 17). The company has a policy to declare and pay dividends on quarterly terms. However in 2012, the company received dividends as opposed to paying dividends which might be attributed to huge investment in the stock exchange market. Therefore the main financing activity for Barclays bank Limited was trade in ordinary shares which enabled the company to pay dividends to the shareholders of the company. On the contrary from the financial statements of HSBC bank, it is clear that the firm had similar financing activities as Barclays bank. The company sold shares and had to pay dividends to the shareholders of the company. The dividends declared by the management amounted to £ 33.956 billion in 2013 and £ 32.628 billion in 2012. There was an increase in the amount used to finance showing that the company sold more shares in 2013 than in 2012 or that the dividend amount increased due to increased profitability from the outcome. However, in terms of which company experienced a greater risk in financing activities it is clear that HSBC assumed more risks due to huge amount committed to finance the activities. Given the turbulent economic environment, it was not certain whether HSBC would enough profits and declare dividends to the shareholders (HSBC Stock Exchange Announcement, 2014; p. 10). Question 3 d) Investment activities by the two banking institutions HSBC Bank invested most of its funds in ordinary shares, non-current assets, intangible assets and financial instruments. Among the investment activities, interests received from the financial derivatives and the proceeds from the sale and maturity of its financial instruments were the most. The company used most of its funds in buying financial instruments which affected largely the net cash flows from the investment activities. The company realized £ 75.367 million from the investing activities higher than in 2012 where the company did not receive anything from the investment (HSBC Stock Exchange Announcement, 2014; p. 10). Much of the funds were used in investing as opposed to getting the returns. On the other hand Barclays bank spent most of its idle funds in investing in financial instruments. The company spent £ 16.628 billion in investment without efforts to dispose the investment to get returns. The amount of investment by Barclays bank increased from £ 5.007 billion in 2012 to £ 16.628 billion (Barclays Banking Group 2014; p. 17). This is a sign of increased confidence by the management and directors in the financial instruments. Evidently, HSBC can be said to be more prudent with its funds since the company devoted less funds in financial instruments and it is notable that the company spread much of its investment with the aim of spreading the risks (Zane, Kane and Marcus, 2004; p. 455). Task 4: The overall strategy used by the two companies HSBC and Barclays have unique ways of managing their cash flows and cash inflows. As noted from the analysis is apparent that even though Barclays bank has a huge volume of assets and liabilities on the balance sheet. HSBC is more prudent in terms of investment activities since the company’s management has been noted to spread the risks evenly in various financial instruments. Besides the working capital management clearly shows the capacity of HSBC to effectively manage the use of liquid assets and acquisition of short term loans from other financial institutions as well from the central bank. Consequently HSBC achieved £ 220.898 in net increase in cash equivalents in the year 2012 and £ 92.75 million in 2013 (HSBC Stock Exchange Announcement, 2014; p. 10). Barclays bank had the lowest net increase in cash and cash equivalents by the end of 2013 and 2012. The bank realized (£ 3.649 billion) in 2013 and (£ 50.424 billion) in 2012 (Barclays Banking Group 2014; p. 17). This is not a good sign of management of cash flows and cash inflows. As a matter of fact, all figures are negative for Barclays bank. Perhaps, the reason for this observation stems from the the bank has focused and devoted majority of its resources in the foreign subsidiary firms where the risks such as foreign exchange risks largely affect the reported figures. Once the figures are converted to the parent firm’s currency the outcome is affected by the deviation ion the exchange rates and the taxation policies which in return influences the cash flows of the company. Bibliography Barclays Banking Group (2014). Financial Statements Report 2014. http://www.newsroom.barclays.com/imagelibrary/downloadMedia.ashx?MediaDetailsID=5943 Bodie, Zane; Alex Kane and Alan J. Marcus (2004). Essentials of Investments, 5th ed. McGraw-Hill Irwin. p. 455. Epstein, Barry J.; Eva K. Jermakowicz (2007). Interpretation and Application of International Financial Reporting Standards. John Wiley & Sons. pp. 91–97 Helfert, Erich A. (2001). "The Nature of Financial Statements: The Cash Flow Statement". Financial Analysis - Tools and Techniques - A Guide for Managers. McGraw-Hill. p. 42 HSBC Stock Exchange Announcement (2014) Financial statement report. http://www.hsbc.com/investor-relations/stock-exchange-announcements Wild, John Paul. (2007) Fundamental Accounting Principles (18th edition ed.). New York: McGraw-Hill Companies. pp. 630–633. Read More