Cashflow Tip – What the Cashflow Statement shows and tells us

The Cashflow Statement is also known as the Statement of Cashflows, and here we look at what the statement shows us. It is one of the 3 main financial statements that businesses report on – the other 2 (used most commonly) are Profit & Loss, and The Balance Sheet.

The cash flow statement reports the actual cash generated and spent during the time period stated in its heading. The period of time is chosen by the company, for example, "For the Three Months Ended 31 December, 2017" or "The Fiscal/Financial Year Ended September 30, 2018". Most common is annual at year end eg 31 Dec or 30 June for Australia.

The cash flow statement actually uses data and the CHANGES between periods from the Profit & Loss and Balance Sheet, and organises and reports the cash generated and used in the following 3 categories:

Operating, Investing and Financial activities

What the Cashflow Statement shows –

The profit & loss or Income Statement is prepared under the accrual basis of accounting, which means the sales/revenues reported may not have been collected yet. Similarly, the expenses reported on the income statement might not have been paid yet. You could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, savvy business people and investors utilize this important financial statement.

Here are a few ways the statement of cash flows is used.

1.     The cash from operating activities is compared to the company's net income (profit/loss). If the cash from operating activities is consistently greater than the net income, the company's net income or earnings are said to be of a "high quality". If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash.

2.     Some investors believe that "cash is king". The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are seen to be good for owner / shareholder value.

3.     There are also some financial models that use the cash flow.

The statement of cash flows has four distinct sections:

1.     Cash generated from operating activities

2.     Cash generated from investing activities

3.     Cash generated from financing activities

4.     Supplemental information.

The differences in a company's balance sheet accounts from one period to the next, will provide much of the needed information. - The changes or differences - in the account balances will likely be entered in one of the sections of the statement of cash flows.

Of the four sections of the statement of cash flows, those balance sheet accounts which affect that section include -

1. Operating Activities

This section reports the net income and then converts it from the accrual basis to the cash basis by using the changes in the balances of current asset and current liability accounts, such as:

Accounts Receivable
Inventory
Prepaid Insurance
Other Current Assets
Notes Payable
Accounts Payable
Wages Payable
Payroll Liabilities
Interest Payable
Income Taxes Payable
Unearned Revenues
Other Current Liabilities

Note – as well as using the changes in current assets and current liabilities, the operating activities section may list adjustments for depreciation expense and for the gains and losses on the sale of long-term assets/investments.

2. Investing Activities

This section reports changes in the balances of long-term asset accounts, such as:

Long-term Investments
Land
Buildings
Equipment
Furniture & Fixtures
Vehicles

Investing activities involve the purchase and/or sale of long-term investments and property, plant and equipment.

3. Financing Activities

This section reports changes in balances of the long-term liability and stockholders' equity accounts, such as:

Notes Payable (generally due after one year)
Bonds Payable
Deferred Income Taxes
Preferred Stock
Paid-in Capital in Excess of Par-Preferred Stock
Common Stock
Paid-in Capital in Excess of Par-Common Stock
Paid-in Capital from Treasury Stock
Retained Earnings
Treasury Stock

Financing activities involve the issuance and/or the repurchase of a company's own bonds or shares as well as short-term and long-term borrowings and repayments.

4. Supplemental Information

This section of the cash flow statement reports the amount of interest and income taxes paid as well as significant exchanges not involving cash. For example, the exchange of company shares for company bonds would be reported here.

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Business Tips – A new way to get a Competitive Advantage?

(Summary of key ideas by Paul Humphreys, of the book The Advantage, by Patrick Lencioni)

After watching his father come home frustrated  and complaining about how his company was managed, as well as working in management roles in large organisations himself , Patrick Lencioni realised  that  the management decisions had a very real impact on workers and customers, and ultimately the business success. There had to be a new way to get a competitive advantage!

He saw in his work that an organisation’s biggest opportunity was not only about strategy, finance, marketing – but the health of the organisation – and it filtered from the top leadership – and that was the new competitive ADVANTAGE.

He also finds that it is ignored by most leaders even though it is simple, because it is seen as TOO easy, and requires some humility to face the truth, is not sophisticated, nor an adrenalin rush, nor easily quantifiable.

It requires being both HEALTHY & SMART -

1. Health - low politics and confusion, high morale, enthusiasm and productivity, and low employee turnover (and clients!),
2. Smart - excel at strategy, marketing, technology and occupies the greatest focus.

Many admit that the characteristics of HEALTH above, would transform their company, but without having a method to foster and encourage it, they gravitate back to focus on the more tangible SMART areas which are more measurable and visible. But the opportunities by being smart/innovative are more competitive and harder to achieve.

Patrick has found that health makes the difference in successful businesses, because most organisations have the smarts within the team. Rallying around  solution works when no politics and confusion occurs. Like healthy families can exist without great wealth.

But health is not easy to define, and is not celebrated in business reporting, although everyone knows what it is like to be in an UNHEALTHY organisation and the misery of politics, dysfunction, bureaucracy and confusion.  The toll of the anguish and frustration on staff and ultimately families is another result.

In the book Patrick explains -

All the competitive advantages we’ve been pursuing during our careers are gone. That’s right. Strategy. Technology. Finance. Marketing. Gone as the key to advantage.

No, those disciplines have not disappeared. They are all alive and well in most organizations. And that’s good, because they’re important. But as meaningful competitive advantages, as real differentiators that can set one company apart from another, they are no longer anything close to what they once were. 

That’s because virtually every organization, of any size, has access to the best thinking and practices around strategy, technology and those other topics. In this age of the internet, as information has become ubiquitous, it’s almost impossible to sustain a competitive advantage based on intellect and knowledge.

However, there is one remaining, untapped competitive advantage out there, and it’s more important than all the others ever were. It is simple, reliable and virtually free. What I’m talking about is organizational health.

The Healthy Organization

A healthy organization is one that has all but eliminated politics and confusion from its environment. As a result, productivity and morale soar, and good people almost never leave. For those leaders who are a bit skeptical, rest assured that none of this is touchy-feely or soft. It is as tangible and practical as anything else a business does, and even more important.

Why? 

• Because even the smartest organization in the world, the one that has mastered strategy and finance and marketing and technology, will eventually fail if it is unhealthy. Trust me, I’ve seen it happen again and again.
  
• But a healthy organization will always find a way to succeed, because without politics and confusion, it will inevitably become smarter and tap into every bit of intelligence and talent that it has.

So if all this is true – and I am absolutely convinced that it is – then why haven’t more companies embraced and reaped the benefits of organizational health? For one, it’s hard. It requires real work and discipline, over a period of time, and it must be maintained. On top of that, it’s not sophisticated or sexy. That means it doesn’t excite a group of executives who are looking for a quick fix or a silver bullet, something that they will be reading about in the Wall Street Journal or Bloomberg Business week. Moreover, in spite of its power, organizational health is hard to measure in a precise, accurate way. It impacts so many disparate areas of an enterprise that it is virtually impossible to isolate it as a single variable and quantify its singular impact on the bottom line.

But the biggest reason that organizational health remains untapped is that it requires courage. Leaders must be willing to confront themselves, their peers, and the dysfunction within their organization with an uncommon level of honesty and persistence. They must be prepared to walk straight into uncomfortable situations and address issues that prevent them from realizing the potential that eludes them.

Organizational health is about making a company function effectively by:

1. Building a cohesive leadership team;
2. Establishing real clarity among those leaders;
3. Communicating that clarity to everyone within the organization; and
4. Putting in place just enough structure to reinforce that clarity going forward.

The advantage of organizational health is undeniable and massive. Companies get more done in less time. They avoid losing their best people. They identify problems earlier and solve them faster. They beat rivals who waste time, money and energy fighting among themselves, which ultimately drives away good employees and customers.

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Business Tax Tip – Do Government tax incentives for small business encourage and stimulate business innovation and economies?

Not according to Chris Evans - professor at the UNSW School of Taxation ＆ Business Law, in an article on Smart Company using the 2015 tax incentives proposed for small business -

The Turnbull government will release its innovation statement in the next few weeks, and it’s widely expected to include tax breaks for startups. The government may abolish capital gains tax (CGT) for investments in early stage companies, especially in the high-tech sector. The idea, promoted by Coalition backbencher David Coleman, is that those who invest in early stage private companies with an annual turnover of less than $1 million will be able to exit their investment at no tax cost.

Innovation - the creation and diffusion of new products, processes and methods - is, and will continue to be, a key driver of productivity, growth and well-being. As the OECD notes, it plays an important role in: “helping address core public policy challenges like health, the environment, food security, education, and public sector efficiency. Innovation-led productivity growth will become even more important in the future to address key challenges like ageing populations and climate change.”

Innovation clearly matters, and it matters a lot. On the surface, therefore, the idea of abolishing CGT on startup investments seems like a great idea. It would achieve the double whammy of showing the government is “doing something” to promote innovation at the same time as giving tax dollars away - always popular.

But using the tax system in an attempt to foster innovation may not be the sensible policy choice.

Tax systems are excellent at achieving the principal objective for which they are designed - raising revenue. They are often notoriously bad at achieving some of the other objectives for which they are so often used and misused, such as attempting to change the behaviour of corporate and private citizens. The tax history of the world is riddled with examples that illustrate the folly of seeking to promote one particular outcome - favour this activity rather than that one, help these taxpayers rather than those - by using parts of the tax system as an often blunt policy instrument.

A history of failure

In the 1970s and 1980s the UK had a disastrous experience when it attempted to establish something similar to the current Australian proposal - the Business Expansion Scheme (BES). The BES became a byword for some of the most blatant and aggressive tax exploitation by unscrupulous investors and their advisers. It was eventually so hedged in with anti-avoidance measures that it became virtually unworkable.

In Australia those familiar with the failure of the so-called Simplified Tax System for small businesses in the early part of this century (subsequently abandoned), or with the current malfunctioning and highly distortionary Wine Equalisation Tax, will readily attest to the perils of trying to use the tax system to achieve non-tax outcomes.

Providing a CGT break for investors in startups falls foul of the three key criteria of efficiency, equity and simplicity by which tax systems are judged.

Chris then argues the proposal will be inefficient, unfair and complex, so read it there, and goes on to suggest better alternatives –

Alternative solutions

So how can the government help to promote innovation without using the tax system?

The answer is relatively straightforward. The OECD suggests it needs to concentrate its policies on five concrete areas for action. These are: effective education and skills strategies; a sound, open and competitive business environment; sustained public investment in an efficient system of knowledge creation and diffusion; increased access and participation in the digital economy; and sound governance and implementation.

Interestingly the OECD notes that support for business innovation should not overly rely on tax incentives. Well designed and competitive grants, access to (government) contracts and support for networks can be better suited to the needs of young and innovative firms than tax incentives.

The government should think long and hard about using yet more tax breaks to stimulate a key sector of the economy. It might also do well to look at the much vaunted success of Silicon Valley, where tax incentives are, and always have been, negligible. An innovation policy that relies too heavily on the tax system for its sustenance is unlikely to be one which can provide the sort of long-term viability and success that Australia’s innovation policy is surely capable of providing.

What do you say about the proposal???

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