Sources and Use (or Misuse) of Funds-A A +A
Thursday, August 29, 2013
THE Cash Flow Statement, an equally important management report as the Balance Sheet and Income Statement, reflects the summary of the sources and spending of cash. It also shows the cash balances at the beginning and end of the calendar or fiscal year. The Cash Flow Statement reports business operations that involves purely cash resources, and excludes non-cash items such as accrual of revenues, depreciation, bad debts and bad orders – said items are reported in the Income Statement. Cash needs to be accounted for as it is a valuable business resource where all other business resources emanate; and which is used to operate the business.
Liquidity or the capability to readily covert resources to cash is an important business characteristic because it enables management to smoothly and freely take a form in order to achieve business objectives. Cash is the lifeblood of a business. It builds and moves the organization and creates new business strengths.
The misuse of cash will have dire effect on business that could lead to business failure. Erroneous judgment on the use of cash will not only be a waste of the resource; it will also cause the erosion of what has been built. Spending has to be in sync with business operation to fuel efficiency. Imagine using premium to fuel a diesel engine.
Cash Flow Statements have to be reviewed alongside the Balance Sheet and Income Statement for a proper and complete financial review. The Cash Flow Statement may show a large balance of cash at the end of the year; and this may be due to two (2) factors – cash receipt is high or cash spending is low. But sometimes, a large cash balance may be due to other factors, i.e., cash receipt is so high (meaning business is good) but cash spending is also abnormally high – wastage (or anomaly) being concealed by high revenue or cash receipts. Wastages will eventually erode the revenue-earning capability of the business.
Management has to look into areas where cash is misused (wastages) - they adversely affect profits and the return on the investment of stockholders. Wastages can be easily identified and analyzed using the Financial Statements; some of which are the following:
Large amount of idle cash is deposited in a current and savings account instead of investing them in temporary or long-term high-yielding placements; High bank account maintaining balances agreed with the bank; Aging Trade Receivables and other receivables, such as advances to officers and employees; Maintenance of abnormally high inventory levels of manufacturing materials and finished goods that could result to obsolescence, impairment and bad orders.
Maintenance of abnormally high inventory levels of materials and supplies such as office supplies, other supplies and machinery and transportation parts. It is best to follow the Just-in-time concept for these types of inventories so as to maximize the use of working capital.
Purchase of nice-to-have capital assets that do not add value to productivity, efficiency, safety and product quality.
Review the Cash Flow Statement, Balance Sheet and Income Statement regularly; and free up that cash tied-up in one of those financial items. A cash-rich business has many advantages – cash is king in business.
Published in the Sun.Star Pampanga newspaper on August 30, 2013.