4 Starting with cash ﬂ ows
Importance of Cash Flows: Cash Flows
Summary for a Business
Business managers, lenders, and investors, quite rightly, focus on cash
ﬂ ows . Cash inﬂ ows and outﬂ ows are the heartbeat of every business.
Without a steady heartbeat of cash ﬂ ows, a business would soon die.
So, we ’ ll start with cash ﬂ ows. For our example I use a busi-
ness that has been operating many years. This established business
makes proﬁ t regularly and, equally important, it keeps in good
ﬁ nancial condition. It has a good credit history, and banks lend
money to the business on competitive terms. Its present share-
owners would be willing to invest additional capital in the
business, if needed. None of this comes easy. It takes good man-
agement to make proﬁ t consistently, to secure capital, and to stay
out of ﬁ nancial trouble. Many businesses fail these imperatives.
Exhibit 1.1 summarizes the company ’ s cash inﬂ ows and out-
ﬂ ows for the year just ended, and shows two separate groups
of cash ﬂ ows. First are the cash ﬂ ows of its proﬁ t - making activi-
ties — cash inﬂ ows from sales and cash outﬂ ows for expenses.
Second are the other cash inﬂ ows and outﬂ ows of the business —
raising capital, investing capital in assets, and distributing some
of its proﬁ t to shareowners.
I assume you ’ re fairly familiar with the cash inﬂ ows and out-
ﬂ ows listed in Exhibit 1.1 . Therefore, I ’ ll be brief in describing
the cash ﬂ ows at this early point in the book:
The business received $ 51,680,000 during the year from sell-
ing products to its customers. It should be no surprise that
this is its largest source of cash inﬂ ow. Cash inﬂ ow from sales
revenue is needed for paying expenses. During the year the
company paid $ 34,760,000 for the products it sells to custom-
ers. And, it had sizable cash outﬂ ows for operating expenses,
interest on its debt (borrowed money), and income tax. The
net result of its proﬁ t - making activities is a $ 3,105,000 cash
increase for the year — an extremely important number that
managers, lenders, and investors watch closely.
Moving on to the second group of cash ﬂ ows during the year,
the business increased the amount borrowed on notes pay-
able by $ 625,000, and its stockholders invested an additional
$ 175,000 in the business. Together these two external sources
of capital provided $ 800,000, which is in addition to the inter-
nal $ 3,105,000 cash from its proﬁ t - making activities during
the year. On the other side of the ledger, the business spent
$ 3,625,000 for building improvements, for new machines and
equipment, and for intangible assets. Finally, the business dis-
tributed $ 750,000 cash to its shareowners from proﬁ t.
The net result of the cash inﬂ ows and outﬂ ows is a $ 470,000 cash
decrease during the year. Don ’ t jump to any conclusions yet; the
net decrease in cash in and of itself is neither good nor bad. You
need more information than just a summary of cash ﬂ ows to come
to any conclusions about the ﬁ nancial affairs of the business.
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