Question

Explain why a company's board of directors may want to determine the CEO's bonus based on cash flows from operating activities rather than based on net income.

Explain how the net cash flow from financing activities could be a negative amount.

Answer 1

Q1 :

Answer :

A company’s board of directors may want to determine the CEO’s bonus based on cash flows from operating activities rather than based on net income to encourage good cash management. Companies can survive net losses but they fail much more quickly when they have negative cash flows (it impacts their abilities to continue operations in the future). Also, net income involves accruals some of which are based on estimates and judgements which could be manipulated to improve net income, whereas they do not impact cash flows.

Q2 :

Answer :

Cash flows from financing may be positive if the company has issued new shares or bonds, or has increased its bank indebtedness. If cash inflows from these items are greater than cash used to pay dividends or to repay debt, then the net balance will be positive. In this case worthwhile to see where extra cash is being used. May be for expansion, and investing in new PPE, or may be to cover daily operating expenses.