Money Management and Cash Generating Efficiency of a Business
Before the bull market ended in 2007, many companies had accumulated large amounts of cash. Exxon Mobil, Microsoft, and Cisco Systems, for example, had amassed more than $100 billion in cash. At that time, the average large company in the United States had 7 percent of its assets in cash. Increased cash can be a benefit or a potential risk. Many companies put their cash to good use. Of course they are wise to have cash on hand for emergencies.
They may also invest in productive assets, conduct research and development, pay off debt, buy back stock, or pay dividends. Sometimes, however, shareholders suffer when executives are too conservative and keep the money in low-paying money market accounts or make unwise acquisitions. For the user of financial statements, the lesson is that it is important to look closely at the components of the statement of cash flows to see how management is spending its cash.
Cash-Generating Efficiency
Managers accustomed to evaluating income statements usually focus on the bottom-line result. While the level of cash at the bottom of the statement of cash flows is certainly an important consideration, such information can be obtained from the balance sheet. The focal point of cash flow analysis is on cash inflows and outflows from operating activities. These cash flows are further used in ratios that measure cash-generating efficiency, which is a company's ability to generate cash from its current or continuing operations. The ratios that analysts use to compute cash-generating efficiency are cash flow yield, cash flows to sales, and cash flows to assets. Cash flow yield is the ratio of net cash flows from operating activities to net income.
The cash flow yield needs to be examined carefully. Keep in mind, for instance, that a firm with significant depreciable assets should have a cash flow yield greater than 1.0 because depreciation expense is added back to net income to arrive at cash flows from operating activities. If
They may also invest in productive assets, conduct research and development, pay off debt, buy back stock, or pay dividends. Sometimes, however, shareholders suffer when executives are too conservative and keep the money in low-paying money market accounts or make unwise acquisitions. For the user of financial statements, the lesson is that it is important to look closely at the components of the statement of cash flows to see how management is spending its cash.
Cash-Generating Efficiency
Managers accustomed to evaluating income statements usually focus on the bottom-line result. While the level of cash at the bottom of the statement of cash flows is certainly an important consideration, such information can be obtained from the balance sheet. The focal point of cash flow analysis is on cash inflows and outflows from operating activities. These cash flows are further used in ratios that measure cash-generating efficiency, which is a company's ability to generate cash from its current or continuing operations. The ratios that analysts use to compute cash-generating efficiency are cash flow yield, cash flows to sales, and cash flows to assets. Cash flow yield is the ratio of net cash flows from operating activities to net income.
The cash flow yield needs to be examined carefully. Keep in mind, for instance, that a firm with significant depreciable assets should have a cash flow yield greater than 1.0 because depreciation expense is added back to net income to arrive at cash flows from operating activities. If