Cash Flow
The amount of cash a company generates and uses during a period, calculated by adding non-cash charges (such as depreciation) to the net income after taxes. Cash flow can be used as an indication of a company's financial strength.
Notes:Cash flow is crucial to companies, having ample cash on hand will ensure that creditors, employees, and others can be paid on time.
The amount of net cash generated by an investment or a business during a specific period. One measure of cash flow is earnings before interest, taxes, depreciation, and amortization. Because cash is the fuel that drives a business, many analysts consider cash flow to be a company's most important financial statistic. Firms with big cash flows are frequently takeover targets because acquiring firms know that the cash can be used to help pay off the costs of the acquisitions.
Financial analysts generally consider cash flow to be the best measure of a company's financial health. Increased cash flow means more funds are available to pay dividends, service or reduce debt, and invest in new assets. On the other hand, reported net income is heavily influenced by a firm's accounting practices. Reduced income generally means lower taxes and more cash, thus the same accounting practices that reduce net income can actually increase cash flow. A firm with large amounts of new investments and corresponding high depreciation charges might report low or negative earnings at the same time it has large cash flows to service debt and to acquire additional assets.
Operating cash flow, calculated as cash flow (the sum of net income and noncash expenses such as depreciation, depletion, and amortization) plus interest expense plus income tax expense, is an important consideration in corporate acquisitions because it indicates the cash flow that is available to service a firm's debt.
Cash flow analysis is the study of the cycle of your business' cash inflows and outflows, with the purpose of maintaining an adequate cash flow for your business, and to provide the basis for cash flow management.
Cash flow analysis involves examining the components of your business that affect cash flow, such as accounts receivable, inventory, accounts payable, and credit terms. By performing a cash flow analysis on these separate components, you'll be able to more easily identify cash flow problems and find ways to improve your cash flow.
A quick and easy way to perform a cash flow analysis is to compare the total unpaid purchases to the total sales due at the end of each month. If the total unpaid purchases are greater than the total sales due, you'll need to spend more cash than you receive in the next month, indicating a potential cash flow problem.
When times get tough, money gets tight. And when money is more difficult and expensive to borrow, it's especially important for small businesses to take steps to ensure that their cash flows keep flowing. Here are five ways to protect your cash flow and help your small business ride out the storm.
Cash Flow management
1) Keep your weather eye open.
One of the key factors in weathering any storm is knowing that it's coming and what direction it's moving. Keep an eye on the leading indicators for your business and be aware of changing economic conditions. Prepare cash flow projections for the next year. This will help you to see what changes need to be made and when. If such-and-such happened and your predicted cash flow dropped x%, what could you do?
2) Review your credit policies and the credit histories of customers and/or clients.
Managing your customers' credit is an important part of cash flow management. Weed out unprofitable customers, those that cost more to maintain than they add to the bottom line. Flag those who have a history of slow payment. Remember that you do not have to extend credit to anyone. If a customer has a history of slow payment, changing the credit terms or even eliminating credit entirely may be necessary.
3) Take action to speed up payment.
First, invoice promptly. Putting off invoicing gives the customer the impression that you don't care how long it takes to get your money. Second, take measures to encourage prompt payment, such as clearly stating payment due dates and sending overdue notices. Use Invoices That Encourage Action gives more suggestions. Use collection services when necessary. Getting the money if you can is always better for your cash flow than a bad debt.
4) See if payments to suppliers can be extended.
On the other side of the coin, check on the credit terms that your small business's suppliers allow. Most suppliers allow thirty days to pay but you may be able to get them to extend that term to sixty or even ninety days, allowing you to keep the money in your cash flow pipeline longer.
5) Renegotiate contracts.
Landlords, lenders and contractors are not impervious to changing economic conditions so trying to renegotiate is worth a shot. For instance, if the lease on the premises of your bricks-and-mortar business is up, you may be able to negotiate a more favourable rate with your landlord - especially when other retail property is standing empty. A less expensive lease will let you free up more of your cash each month and get more of a cash flow going.
Remember, the outflow part of cash flow is never a problem; money will always run out of your business easily. Keeping the money coming in on a regular, sustained basis is the tricky part of cash flow management. Following the suggestions above will make it easier to keep your cash flow flowing.
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Wednesday, August 20, 2008
Monday, August 11, 2008
Sensitivity Analysis - Introduction
In a decision problem, the analyst may want to identify cost drivers as well as other quantities for which we need to acquire better knowledge in order to make an informed decision. On the other hand, some quantities have no influence on the predictions, so that we can save resources at no loss in accuracy by relaxing some of the conditions. Sensitivity analysis can help in a variety of other circumstances which can be handled by the settings illustrated below:
· to identify critical assumptions or compare alternative model structures
· guide future data collections
· detect important criteria
· optimize the tolerance of manufactured parts in terms of the uncertainty in the parameters
· optimize resources allocation
· model simplification or model lumping, etc.
However there are also some problems associated with sensitivity analysis in the business context:
Variables are often interdependent, which makes examining them each individually unrealistic, e.g.: changing one factor such as sales volume, will most likely affect other factors such as the selling price.
Often the assumptions upon which the analysis is based are made by using past experience/data which may not hold in the future.
Assigning a maximum and minimum (or optimistic and pessimistic) value is open to subjective interpretation. For instance one persons 'optimistic' forecast may be more conservative than that of another person performing a different part of the analysis. This sort of subjectivity can adversely affect the accuracy and overall objectivity of the analysis.
· to identify critical assumptions or compare alternative model structures
· guide future data collections
· detect important criteria
· optimize the tolerance of manufactured parts in terms of the uncertainty in the parameters
· optimize resources allocation
· model simplification or model lumping, etc.
However there are also some problems associated with sensitivity analysis in the business context:
Variables are often interdependent, which makes examining them each individually unrealistic, e.g.: changing one factor such as sales volume, will most likely affect other factors such as the selling price.
Often the assumptions upon which the analysis is based are made by using past experience/data which may not hold in the future.
Assigning a maximum and minimum (or optimistic and pessimistic) value is open to subjective interpretation. For instance one persons 'optimistic' forecast may be more conservative than that of another person performing a different part of the analysis. This sort of subjectivity can adversely affect the accuracy and overall objectivity of the analysis.
COGS,Gross matrgin Etc.
Operating Income
The amount of profit realized from a business's own operations, but excluding operating expenses (such as cost of goods sold) and depreciation from gross income. Also referred to as "operating profit" or "recurring profit". Calculated as:
Operating income would not include items such as investments in other firms, taxes or interest expenses. In addition, nonrecurring items such as cash paid for a lawsuit settlement are often not included. Operating income is required to calculate operating margin, which describes a company's operating efficiency
An individual's total personal income before taking taxes or deductions into account.
1. Your gross income is how much you make before taxes. It is the figure people are looking for when they ask how much you gross a month.2. This is an important number when analyzing a company, it indicates how efficiently management uses labor and supplies in the production process. Keep in mind that gross income varies significantly from industry to industry.2. A company's revenue minus cost of goods sold. Also called "gross margin" and "gross profit".
Cost Of Goods Sold - COGS
The direct costs attributable to the production of the goods sold by a company. This amount includes the cost of the materials used in creating the good along with the direct labor costs used to produce the good. It excludes indirect expenses such as distribution costs and sales force costs. COGS appears on the income statement and can be deducted from revenue to calculate a company's gross margin.Also referred to as "cost of sales".
COGS is the costs that go into creating the products that a company sells; therefore, the only costs included in the measure are those that are directly tied to the production of the products. For example, the COGS for an automaker would include the material costs for the parts that go into making the car along with the labor costs used to put the car together. The cost of sending the cars to dealerships and the cost of the labor used to sell the car would be excluded. The exact costs included in the COGS calculation will differ from one type of business to another. The cost of goods attributed to a company's products are expensed as the company sells these goods. There are several ways to calculate COGS but one of the more basic ways is to start with the beginning inventory for the period and add the total amount of purchases made during the period then deducting the ending inventory. This calculation gives the total amount of inventory or, more specifically, the cost of this inventory, sold by the company during the period. Therefore, if a company starts with P10 million in inventory, makes P2 million in purchases and ends the period with P9 million in inventory, the company's cost of goods for the period would be P3 million (P10 million + P2 million - P9 million).
The amount of money that a company actually receives during a specific period, including discounts and deductions for returned merchandise. It is the "top line" or "gross income" figure from which costs are subtracted to determine net income. Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold.Revenue is also known as "REVs". Revenue is the amount of money that is brought into a company by its business activities. In the case of government, revenue is the money received from taxation, fees, fines, inter-governmental grants or transfers, securities sales, mineral rights and resource rights, as well as any sales that are made.
Gross Margin
A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. The gross margin represents the percent of total sales revenue that the company retains after incurring the direct costs associated with producing the goods and services sold by a company. The higher the percentage, the more the company retains on each peso of sales to service its other costs and obligations.
This number represents the proportion of each peso of revenue that the company retains as gross profit. For example, if a company's gross margin for the most recent quarter was 35%, it would retain P0.35 from each peso of revenue generated, to be put towards paying off selling, general and administrative expenses, interest expenses and distributions to shareholders. The levels of gross margin can vary drastically from one industry to another depending on the business. For example, software companies will generally have a much higher gross margin than a manufacturing firm.
The amount of profit realized from a business's own operations, but excluding operating expenses (such as cost of goods sold) and depreciation from gross income. Also referred to as "operating profit" or "recurring profit". Calculated as:
Operating income would not include items such as investments in other firms, taxes or interest expenses. In addition, nonrecurring items such as cash paid for a lawsuit settlement are often not included. Operating income is required to calculate operating margin, which describes a company's operating efficiency
An individual's total personal income before taking taxes or deductions into account.
1. Your gross income is how much you make before taxes. It is the figure people are looking for when they ask how much you gross a month.2. This is an important number when analyzing a company, it indicates how efficiently management uses labor and supplies in the production process. Keep in mind that gross income varies significantly from industry to industry.2. A company's revenue minus cost of goods sold. Also called "gross margin" and "gross profit".
Cost Of Goods Sold - COGS
The direct costs attributable to the production of the goods sold by a company. This amount includes the cost of the materials used in creating the good along with the direct labor costs used to produce the good. It excludes indirect expenses such as distribution costs and sales force costs. COGS appears on the income statement and can be deducted from revenue to calculate a company's gross margin.Also referred to as "cost of sales".
COGS is the costs that go into creating the products that a company sells; therefore, the only costs included in the measure are those that are directly tied to the production of the products. For example, the COGS for an automaker would include the material costs for the parts that go into making the car along with the labor costs used to put the car together. The cost of sending the cars to dealerships and the cost of the labor used to sell the car would be excluded. The exact costs included in the COGS calculation will differ from one type of business to another. The cost of goods attributed to a company's products are expensed as the company sells these goods. There are several ways to calculate COGS but one of the more basic ways is to start with the beginning inventory for the period and add the total amount of purchases made during the period then deducting the ending inventory. This calculation gives the total amount of inventory or, more specifically, the cost of this inventory, sold by the company during the period. Therefore, if a company starts with P10 million in inventory, makes P2 million in purchases and ends the period with P9 million in inventory, the company's cost of goods for the period would be P3 million (P10 million + P2 million - P9 million).
The amount of money that a company actually receives during a specific period, including discounts and deductions for returned merchandise. It is the "top line" or "gross income" figure from which costs are subtracted to determine net income. Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold.Revenue is also known as "REVs". Revenue is the amount of money that is brought into a company by its business activities. In the case of government, revenue is the money received from taxation, fees, fines, inter-governmental grants or transfers, securities sales, mineral rights and resource rights, as well as any sales that are made.
Gross Margin
A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. The gross margin represents the percent of total sales revenue that the company retains after incurring the direct costs associated with producing the goods and services sold by a company. The higher the percentage, the more the company retains on each peso of sales to service its other costs and obligations.
This number represents the proportion of each peso of revenue that the company retains as gross profit. For example, if a company's gross margin for the most recent quarter was 35%, it would retain P0.35 from each peso of revenue generated, to be put towards paying off selling, general and administrative expenses, interest expenses and distributions to shareholders. The levels of gross margin can vary drastically from one industry to another depending on the business. For example, software companies will generally have a much higher gross margin than a manufacturing firm.
Depreciation
What Is Depreciation?
Depreciation is the process by which a company allocates an asset's cost over the duration of its useful life. Each time a company prepares its financial statements, it records a depreciation expense to allocate a portion of the cost of the buildings, machines or equipment it has purchased to the current fiscal year. The purpose of recording depreciation as an expense is to spread the initial price of the asset over its useful life. For intangible assets - such as brands and intellectual property - this process of allocating costs over time is called amortization. For natural
resources - such as minerals, timber and oil reserves - it's called depletion.
Assumptions
Critical assumptions about expensing depreciation are left to the company's management. Management makes the call on the following things:
· Method and rate of depreciation
· Useful life of the asset
· Scrap value of the asset
Calculation Choices Depending on their own preferences, companies are free to choose from several methods to calculate the depreciation expense. To keep things simple, we'll summarize the two most common methods:
Straight-line method - This takes an estimated scrap value of the asset at the end of its life and subtracts it from its original cost. This result is then divided by management's estimate of the number of useful years of the asset. The company expenses the same amount of depreciation each year. Here is the formula for the straight-line method: Straight line depreciation = (original costs of asset – scrap value)/est'd asset life
Accelerated Methods - These methods write-off depreciation costs more quickly than the straight-line method. Generally, the purpose behind this is to minimize taxable income. A popular method is the 'double declining balance', which essentially doubles the rate of depreciation of the straight-line method: Double declining depreciation = 2 x straight line rate Double Declining Depreciation = 2 x (original costs of asset – scrap value / est'd asset life)
The Impact of Calculation Choices As an investor, you need to know how the choice of depreciation method affects an income statement and balance sheet in the short term. Here's an example. Let's say The Sherry Company purchased a new IT system for P2 million. Sherry estimates that the system has a scrap value of P500,000 and reckons it will last 15 years. According to the straight-line depreciation method, Tricky's depreciation expense in the first year after buying the IT system would be calculated as the following:
(P2,000,000 - P500,000)/15 = P100,000
According to the accelerated double-declining depreciation, Sherry's depreciation expense in the first year after buying the IT system would be this:
2 x straight line rate = 2 x(P2,000,000 - P500,000)/15 2 x straight line rate = P200,000
So, the numbers show that if Sherry uses the straight-line method, depreciation costs on the income statement will be significantly lower in the first years of the asset's life (P100,000 rather than the P200,000 rendered by the accelerated depreciation schedule). That means there is an impact on earnings. If Sherry is looking to cut costs and boost earnings per share, it will choose the straight-line method, which will boost its bottom line.
A lot of investors believe that book value, or net asset value, offers a fairly precise and unbiased valuation metric. But, again, be careful. Management's choice of depreciation method can also significantly impact book value: determining Tricky's net worth means deducting all external liabilities on the balance sheet from the total assets--after accounting for depreciation. As a result, since the value of net assets doesn't shrink as quickly, straight-line depreciation gives Sherry a bigger book value than the value a faster
Depreciation is the process by which a company allocates an asset's cost over the duration of its useful life. Each time a company prepares its financial statements, it records a depreciation expense to allocate a portion of the cost of the buildings, machines or equipment it has purchased to the current fiscal year. The purpose of recording depreciation as an expense is to spread the initial price of the asset over its useful life. For intangible assets - such as brands and intellectual property - this process of allocating costs over time is called amortization. For natural
resources - such as minerals, timber and oil reserves - it's called depletion.
Assumptions
Critical assumptions about expensing depreciation are left to the company's management. Management makes the call on the following things:
· Method and rate of depreciation
· Useful life of the asset
· Scrap value of the asset
Calculation Choices Depending on their own preferences, companies are free to choose from several methods to calculate the depreciation expense. To keep things simple, we'll summarize the two most common methods:
Straight-line method - This takes an estimated scrap value of the asset at the end of its life and subtracts it from its original cost. This result is then divided by management's estimate of the number of useful years of the asset. The company expenses the same amount of depreciation each year. Here is the formula for the straight-line method: Straight line depreciation = (original costs of asset – scrap value)/est'd asset life
Accelerated Methods - These methods write-off depreciation costs more quickly than the straight-line method. Generally, the purpose behind this is to minimize taxable income. A popular method is the 'double declining balance', which essentially doubles the rate of depreciation of the straight-line method: Double declining depreciation = 2 x straight line rate Double Declining Depreciation = 2 x (original costs of asset – scrap value / est'd asset life)
The Impact of Calculation Choices As an investor, you need to know how the choice of depreciation method affects an income statement and balance sheet in the short term. Here's an example. Let's say The Sherry Company purchased a new IT system for P2 million. Sherry estimates that the system has a scrap value of P500,000 and reckons it will last 15 years. According to the straight-line depreciation method, Tricky's depreciation expense in the first year after buying the IT system would be calculated as the following:
(P2,000,000 - P500,000)/15 = P100,000
According to the accelerated double-declining depreciation, Sherry's depreciation expense in the first year after buying the IT system would be this:
2 x straight line rate = 2 x(P2,000,000 - P500,000)/15 2 x straight line rate = P200,000
So, the numbers show that if Sherry uses the straight-line method, depreciation costs on the income statement will be significantly lower in the first years of the asset's life (P100,000 rather than the P200,000 rendered by the accelerated depreciation schedule). That means there is an impact on earnings. If Sherry is looking to cut costs and boost earnings per share, it will choose the straight-line method, which will boost its bottom line.
A lot of investors believe that book value, or net asset value, offers a fairly precise and unbiased valuation metric. But, again, be careful. Management's choice of depreciation method can also significantly impact book value: determining Tricky's net worth means deducting all external liabilities on the balance sheet from the total assets--after accounting for depreciation. As a result, since the value of net assets doesn't shrink as quickly, straight-line depreciation gives Sherry a bigger book value than the value a faster
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