Financial analysis of the cash flow list from the balance sheets

We have explained all the items of the cash flow statement in both direct and indirect methods . Today we are going to learn about an important point which is how to read the cash flow statement and come up with certain results . No doubt it is important to know how to prepare a cash flow statement ,but it is more important to know how to read and analyze it correctly . So we will learn the analysis of the items of the cash flow statement from operating , investing or financing activities.

Financial analysis of the operating cash flow statement 

In the financial analysis we compare the present period to the previous one , say for example in 2018 and 2017 . First we see the amount of operating cash flow . Has it increased or decreased ? What is the ratio of increase or decrease ? Meaning that in 2018 the net   operating cash flow was 6 millions and 10 2017 was 5.250 millions, so the increase ratio is (6-5.250 ) /5.25=14 %  nearly . Initially it is good that the operating cash flow statement for the present year has increased from the previous year  , however we have to analyze each item of the  operating cash flow statement .

First : clients’ receipts 

Assume that in 2018 clients’ receipts were 15 millions , whereas in 2017 they were 13 millions . or if they were13 millions in 2018 and 15 millions in 2017 .Is that a positive or negative indicator ?

We can’t decide that till we review  company sales for this year with comparison to the last year and the analysis of credit or cash sales . Namely I should see if the sales increased or decreased , for example in 12018 they may be 80 millions and in 2017 50 millions . consequently the collections would increase as a result of the sales increase . But  we have to answer some questions : Is the present year increase  in cash sales or credit sales ? What is the rate of cash sales to gross sales ? What is the rate of credit  sales tohan the last year or because of the  gross sales ? After that I can decide and analyze the cause of increase in clients’ receipts , is it because the company succeeded in collecting a big amount of credit sales? Or because of the present year sales increase so the increase in collections is logical .

An example on the rate of cash sales 

The sales in 2017  were 50 millions

25%cash means 12.5 millions 

75% credit means 37.5 millions 

The company collected 60% of credit sales that is 

60% ✕ 37.5 millions = 22.5 millions 

So the gross cash receipts from clients and sales in general is = 12.5 + 22.5 =35 millions 

In 2018 the sales were 60 millions 

40% cash that is 24 millions 

60 % credit that is 36 millions 

The company had 50 % sales on credit

 50% ✕ 36 millions = 18 millions 

Gross receipts from clients and sales in general is 

=18 + 24 = 42 millions.

Financial analysis of clients’  accounts 

The sales  in 2018 are more  than in 2017 , which is a good indicator . There are detailed analyses for sales on the level of each item  , sales centers , clients and others  .What is good is the increase in cash sales to the gross sales and also the increase in the value of cash sales to be  nearly doubled  from 12.5 millions to 24 millions . This is a good indicator because it provides the company with liquidity in comparison with credit sales and credit periods . However the credit sale is required too . This topic will be discussed in credit and clients’ accounts series .The credit sales decreased in a little rate from 37.5 millions to 36 millions  ( 4.16 % ) . Notice the decrease in collections from credit clients from 22.5 millions to 18 millions ( 25 % ) . We have to know the reason if it is the few collections during the year or the increase in granted credit from the company to the clients in  order to get a bigger share in the market . Or is it a natural reason that is the good collecting through the year and  during credit periods . The decrease in collections at the end of the year  is a result of sales processes made before the end of the financial period and they will be collected at the beginning of the next period . All these questions will be answered by the financial analysis . They differ from one company to another but the main idea is that while working on the analysis of collections from clients , we have to be aware that the major cause of collections increase or decrease and if it is natural or not .

Second : payments for suppliers and creditors and expenses :

It is better for any company to delay payback and payment for suppliers in order to maintain high liquidity through having longer  payment periods and credits from the suppliers than that it gives to its clients . On analyzing the payments for creditors and clients , we have to consider the purchases and expenses that took place during the present  financial period  and compare them to the previous period .

In other words if the payments for suppliers are 15 millions whereas in the last year they were 13 millions , and the purchases during the present year were 40 millions but in the last year they were 38 millions . We will have to determine the cause the increase in payments despite of the less purchases , which can be a set of reasons :

1- the company’s  tendency  to cash purchases more than credit purchases

For example the company's tendency to external purchases  because of the material quality in comparison with local material and the difficulty in getting good credit periods . The company may have a good credit period from the suppliers but at the end of the financial period it contracted with another supplier to get more quantities for a less price  . That’s why payments for suppliers are great when compared to the similar period . 

2- payments for employees as salaries , wages and bonuses :

In this item there should be an analysis  of  each section ( operating salaries , administrative and marketing  salaries ) , a comparison of the figures in each section with total  salaries , a comparison of total salaries to the expenses value and also a  comparison of paid salaries to the gross paid operating cash flow statement. 

The idea is to know the ratio of salaries to the total cash payments which is really important in preparing cash balances and also to determine the value of salaries expenses that mustn't be exceeded by the company . 

The important point in operating cash flow statement analysis is the cash margin . The cash margin is the receipts from clients deducted from them by the payments for suppliers .The company would better to work on increasing the rate of cash margin in each period more than the previous one . 

This is because this makes improvements in cash receipts and this will be reflected positively on operating cash flow which indicates the efficiency of the company administration of the working capital .   

Payments of financing interests and profits distributions :

The value of financing interests  must be analyzed . Is there an increase in them during the present year in  comparison to the previous one ? Is this increase in financing interests a result of loans ?What is the effect of these loans on the sales increase and company profits increase ? What is the ratio of  paid financing interests to the gross paid operating cash flow ? 

Payments and receipts to and from the credit and other credit balances :

We have to analyze the items of credit and other credit balances in order to know the amounts the company has collected or paid during  the present period and compare them to other periods . 

On analysis of the net operating cash flow statement either it is  cash inflow ( a great number ) or cash outflow (a  low or negative number ) , we have to decide the weaknesses and strengths  points . Namely there can be receipts number in less periods but the financing interests or salaries have increased greatly with no noticeable  increase in sales . Consequently this affects the  net operating cash flow statement and it is considered an alarm of a problem in the future periods .

There can be another reason for the decrease in the  net operating cash flow statement as the company paid large amounts of compensations or allocations used  in lost disputes of the company .

The major idea is that I should be aware of every number in the operating cash flow statement either payments or receipts   increase or decrease , the reason, the ratio of each receipt number to the total operating receipts in general and also the ratio of each payment number to the total operating payments in general and general analyses too . 

In the next part we will learn the analysis of investing and financing activities .