Question

1. The meaning & importance of operating cash flows

2. The reason net income and cash flow are not the same

3. Potential ways a company can improve cash flow or help prevent future cash shortage problems

Answer 1

1. The meaning & importance of operating cash flows.

As per IAS – 7 on Statement of Cash Flow, Operating Cash Flows are the cash generated from the Operating Activities of the an entity, where Operating Activities has been defined as the main revenue producing activities of the entity that are not investing or financing activities, so operating cash flow include cash received from customers and cash paid to suppliers and employees.

In simple term, operating cash flow is the amount of cash generated by a company’s primary business operations. Further, the operating cash flow also indicates whether or not a company has ability to generate sufficient cash to operate and continue its business operations.

The question here arises is why Operating Cash Flows has so much importance, the operating cash flow is the important/major indicator of financial health of the company, it is through the analysis of OCF it can be construed whether or not the company can meet its various expenses, such as labor costs, repayment of short term debt, payment to suppliers etc.

2. The reason net income and cash flow are not the same.

Net Income is the net profit earned by the company during the period, while cash flows are the cash going in and out of the company. Net Income can also be called accounting profit calculated by reducing operating expenses and other non-cash expenses such as amortization, depreciation and taxes from net revenue, While cash flow incorporates day to day operating activities. The key point which causes difference,

• Accrued Expenses are considered for calculation of net income for which no cash payments might have been made.
• Prepaid Expenses are cash payments but are recorded as assets instead of expenses, as it is yet to accrue.
• Credit Sales are considered in calculation of net income, because they have been earned, though receipts are still pending.

3. Potential ways a company can improve cash flow or help prevent future cash shortage problems.

Cash is the important element in any business. Cash is the vary requirement for the survival of the business. The requirement of cash is not met through the Sales or other revenue but also by reducing the costs.

By following ways the companies can improve cash flow,

1. Costs Cut: Costs cuts are the most followed method of improving cash flows. Entity tends to reduce the non-necessary costs. Recently, many companies are going through tough times have been reducing their costs on continues basis by laying employees, decreasing production.
2. Delay Expansions: Business expansions costs companies heavily as it requires high cash, which may lead to cash shortage or liquidity problem. The companies can keep the expansion plans in abeyance for some period.
3. Early recovery from customers: The business can seek early recovery from the customers by reducing the credit period allowed to customers. Generally seen most of the cash blocked due to delay in recovery from customers.
4. Late Payment to Suppliers: Though it is a very risky strategy but businesses do adopt these types of strategies to overcome short liquidity problem as maximum cash flows out of the business as Payment to the Suppliers.