By Zakiyyah Bhamjee of the Tariro Foundation
As far as the accounting of your business is concerned, there are a few key reports that share vital information about your business with relevant stakeholders, these statements can also be used by the entrepreneur as an indicator of the financial health of their business. One of these reports being the statement of cash flows.
Through the sorcery of accounting and resulting non cash based transactions, companies that appear extremely profitable can in reality be at financial risk should they not be generating sufficient cash from their profits.
Cash Flow Defined
If you believe in the old adage “it takes money to make money,” then you grasp the concept of cash flows and what it means to a company. As the term suggests, cash flow is the money that flows in (positive cashflow) and out (negative cashflows) of your business. The cash flow statement is a good consolidated indicator of a businesses cash inflows and outflows; it further stratifies these into three distinctive categories - operating activities, investing activities and financing activities.
Cash flows from operating activities indicate the cash generated from core activities (e.g selling of merchandise) of the entity as opposed to peripheral activities e.g. investing or borrowing (assuming that the entity is not a financial institution.)
Cash flows from investing activities reports the aggregate change in a companies cash balances as a result of gains/losses from investments as well as movements in cash balances resulting from amounts spent on investments in capital assets e.g. plant & equipment.
Cash flows from financing activities express the total net cash flow from financing activities e.g debt issuance, repayment of debt, issue/repurchase of shares, dividend payments to name a few.
Cash Flow Ratios
- Operating Cash Flow Ratio = cash flows from operating activities / current liabilities
The ratio indicates whether an entity is generating sufficient cash flows from core activities to meet it’s short term debt obligations
- Cash Flow Margin Ratio (%) = cash flow from operating activities / net sales
The cash flow margin ratio is a measure of how efficiently a company converts it sales into cold hard cash, it indicates how many rands in cash we get for every rand in sales. A percentage at the higher end of the scale indicates that the entity has more cash available from sales. If cash flows from operating activities per the statement of cash flows is negative, this indicates that even as the entity is generating revenue it is losing money.
- Asset Efficiency Ratio = cash flow from operating activities / total assets
This elementary computation indicates how well an entity uses its assets to generate cash flows. A useful tip to increase the relevance of the computation is as opposed to using total assets one could rather use operating assets only e.g property, plant & equipment
- Interest Coverage Ratio = (cash flow from operating activities + interest paid + taxes paid) / interest paid
The resulting multiple indicates the entities ability to make interest payments on its interest bearing borrowings. A highly leveraged entity is expected to have a lower multiple. An interest coverage ratio less than one can be a cause for concern.
- External Financing Index Ratio = cash flow from financing activities / cash flow from operating activities
The ratio serves to indicate the level of dependency of the entity on financing. Put plainly, the higher the number the greater the dependency of the company on external money.
The above is by no means exhaustive, your inputs, further questions & recommendations are always welcome. I look forward to your emails and posts and am more than happy to review the cash flow position of your business should you wish - just drop me a note.
Zakiyyah Bhamjee CA(SA) is an Entrepreneur and the group financial manager of the Bhamjee Group of Companies and the Entrepreneurship Portfolio Head of the Tariro foundation. She is passionate about Africa and is making progress towards defining her role in the growth story that South Africa has to share with the world. She graduated at the University of Pretoria having completed Bcom (Hons) with Specialization in Accounting Sciences in November 2011, successfully passing the SAICA (South African Institute of Chartered Accountants) Qualifying Exam in January 2012 as well as the IRBA (Independent Regulatory Board for Auditors) Public Practice Examination in November 2013. She completed articles at PricewaterhouseCoopers, South Africa and qualified as a Chartered Accountant CA(SA) and Registered Public Accountant - RA in December 2014. She is involved in various PBOs and aid projects. Zakiyyah can be reached on email@example.com
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