Cash Flow (Practical Experience)

Cash Flow is the second most important thing after profit. If a company attains high profit constantly but  has low or negative cash flow, something maybe going wrong.

There are some reasons where a company attains high profit but low cash flows.

1 Long Term Capital Investment

Company will use cash earned from profit to invest in long term assets such as buying building, factory or machine for future expansion.  Long term assets usually require total cash payment initially and expensed in income statement across its living year. Therefore, when a company invest in long term assets, it will cause a large outflow of cash in that particular year.

Long term capital investment can be traced by monitoring the cash flow from investing activities in cash flow statement.

2 Short Term Capital Investment

Company will use their cash in buying materials to produce product (inventory) or borrow to the customers (Receivable). It is reasonable for inventory and receivables to maintain specific ratio with revenue.(revenue increases 5%, inventory and receivables increase 5%). If inventory and receivables increase too much(more than revenue), it is not a good sign because it may cause a writeoff afterwards.(cause by obsolesce of inventory or bad debt of receivables )

Short term capital investment can be traced by monitoring the adjustment of working capitals in cash flow fro operating activities section in cash flow statement.

3 Paying Dividend

Company can use the profit to pay dividend. If company has a 100% dividend payout ratio policy, it means company will pay all the profits as dividend to shareholders, and no cash flow will retain from the  profit.

4 Paying Debts

Company can use extra cash generated from profit to pay off its debts. The good thing of paying debt is the net profit margin in the following years will be increased due to the reduction of interest expense.