Question

Why is it important to track cash flow by period.

How can you modify net income to approximate cash flow?

What factors influence the timing of receipts when you have a collections policy for accounts receivable that comes in over time?

How do you approximate the net cash flow for a project where the cash is commingled with the rest of the business?

Answer 1

Why is it important to track cash flow by period

A cash flow statement is not only concerned with the amount of the cash flows but also the timing of the flows. Many cash flows are constructed with multiple time periods. For example, it may list monthly cash inflows and outflows over a year’s time. It not only projects the cash balance remaining at the end of the year but also the cash balance for each month. To pay it’s short term obligation it is important to know the position of the cash as on date.

Working capital is an important part of a cash flow analysis. It is defined as the amount of money needed to facilitate business operations and transactions, and is calculated as current assets (cash or near cash assets) less current liabilities (liabilities due during the upcoming accounting period). Computing the amount of working capital gives you a quick analysis of the liquidity of the business over the future accounting period. If working capital appears to be sufficient, developing a cash flow budget may not be critical. But if working capital appears to be insufficient, a cash flow budget may highlight liquidity problems that may occur during the coming year.

How can you modify net income to approximate cash flow?

For approximate cash flow it is important to add back non-cash expenses like depreciation & non-operating items like interest on financing activities & loss or gain on fixed asset. Taxes also are added initially then deducted after working capital changes

What factors influence the timing of receipts when you have a collections policy for accounts receivable that comes in over time?

The following factors directly and indirectly influence timing of the receipts:

(1) Size of Credit Sales:- The volume of credit sales is the first factor which increases or decreases the size of receivables. If a concern sells only on cash basis as in the case of Bata Shoe Company, then there will be no receivables. The higher the part of credit sales out of total sales, figures of receivables will also be more or vice versa.

(2) Credit Policies:- A firm with conservative credit policy will have a low size of receivables while a firm with liberal credit policy will be increasing this figure. If collections are prompt then even if credit is liberally extended the size of receivables will remain under control. In case receivables remain outstanding for a longer period, there is always a possibility of bad debts.

(3) Terms of Trade:- The size of receivables also depends upon the terms of trade. The period of credit allowed and rates of discount given are linked with receivables. If credit period allowed is more than receivables will also be more. Sometimes trade policies of competitors have to be followed otherwise it becomes difficult to expand the sales.

(4) Expansion Plans:- When a concern wants to expand its activities, it will have to enter new markets. To attract customers, it will give incentives in the form of credit facilities. The period of credit can be reduced when the firm is able to get permanent customers. In the early stages of expansion more credit becomes essential and size of receivables will be more.

(5) Relation with Profits:- The credit policy is followed with a view to increase sales. When sales increase beyond a certain level the additional costs incurred are less than the increase in revenues. It will be beneficial to increase sales beyond the point because it will bring more profits. The increase in profits will be followed by an increase in the size of receivables or vice-versa.

(6) Credit Collection Efforts:- The collection of credit should be streamlined. The customers should be sent periodical reminders if they fail to pay in time. On the other hand, if adequate attention is not paid towards credit collection then the concern can land itself in a serious financial problem. Efficient credit collection machinery will reduce the size of receivables.

(7) Habits of Customers:- The paying habits of customers also have bearing on the size of receivables. The customers may be in the habit of delaying payments even though they are financially sound. The concern should remain in touch with such customers and should make them realize the urgency of their needs.

How do you approximate the net cash flow for a project where the cash is commingled with the rest of the business?

When approximating the cash flow of a project, first consider the initial cash outlay. refers to the amount of all the cash inflows and outflows that occur when the project starts. When starting a project, there are initial costs involved, such as purchasing equipment’s, labor costs and the costs of other utilities necessary to kick start the project. Adding up all the costs involved to create the project enables you to have a clear mind of the expenses like depreciation, overhead expenses & operating working capital change over different phases of the project.