Question

QUESTION FOUR

1) How does a company generate Cash?

2) How does a company use Cash?

3) To what extent do accounting numbers reflect economic reality

4) How do you incorporate in your financial analysis many ‘assets’ not reported in the financial
statements that generate more income in the future ( capacity of assets in place to generate
future income, role of better management/executives, loyal customers etc)

5) Are positive accounting earnings a sign of superior performance (can support increase in
wages, taxes, and bonuses?). How do you factor cost of equity

Answer 1

Companies generate cash from various sources. Some of them are discussed below:

• Cash from core business operations : this is the mode common menthod of generating cash. Firms receive cash payments in exchange of the products sold.
• Cash from sale of assets: When an existing asset is sold, it generates cash.
• Cash from assuming long term liabilities : when a firm takes on external debt or issue shares, cash is received by the firm.
• Other sources of cash : Cash from interest or dividend received, payment by a bad debtor etc can generate extra cash for the business.

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The cash balance with the company can be utilised for following purposes :

• Purchasing of raw materials: The raw materials required to manufacture final product or service involves payment in cash or credit. Either way cash is spent for purchasing raw material.
• Payment of dividend or interest : dividend on shared and interest on any loan taken is to be paid in cash.
• Repayment of long term liabilities : any fall in liabilities (like repayment of a due loan) involves dispersing firm's cash balance.
• Purchase of assets : Purchase of machinery, building etc involves acquiring of assets and capital cash expenditure.

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In my opinion, accounting numbers is subjectively accounted for and have to ability to re shape the reality according to the firm's needs. Even after meeting all the accounting standards, it might give a flawed picture of firm's value to keep going in the market. Some accounting numbers are nothing but just an estimates like depreciation expenses, provisions for bad and doubtful debtors, and etc. Such figures can be played with to exhibit a nicer or worse position of the firm than what it actually is. Also, all the financial statements of the firm are based on accrual basis. The cash flow position of the firm might be collapsing but when judged on the financial statements' basis, it may be surviving very well.

Manipulation of balance sheet and statement of profit and loss (like recording of fictitious assets, overstating assets and understating liabilities) figures leads to serious crimes and accounting frauds.

So even though the statements are mathematically accurate, it might not present a fair view of the company and hence, it doesn't necessarily depicts the economic reality.

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Financial assets that are not reported in financial statements may provide more profit to the company. But it is difficult to identify and quantify such assets. But it's impact can be observed in the quantifiable part of the financial statements where sales are increasing, costs are decreasing improvement in efficiency and effectiveness, meeting targets, fall in employee turnover. This type of financial data can provide evidence effectiveness of non recordable financial data. These can't be directly incorporated in the statement but the final statements' figures can be reasoned via qualitative financial data.

Hope it helps. Thank you