May 12, 2001|
Cash flows vs income statements
While profit statements can be distorted by anomalies in the accounting policies, the cash flow statement can be considered as a gospel for investors. A cash flow in simple terms is a statement, which summarizes movement of cash (the lifeline of any business) in an entity. There are several issues on which cash flow statement scores over the income statement. While the profit and loss statement gives a summarized view on the profitability of the entity, cash flow measures the health of the business as well.
Income statement ignores time value of money: †Income statement does not look at the time value of money. A typical example of the same could be refinery companies. The growing deficit in the oil pool account has reflected in increased receivables in the books of oil companies. The deficit in totality is estimated in the range of Rs 100 bn. In other words, though oil companies must have booked sales (profits thereon), they have in fact only resulted in huge receivables in the books of these companies. The government has decided to issue oil bonds to oil companies in lieu of their respective oil pool account receivables. With lack of a definite period for redemption of oil bonds it would take much longer before they actually make profits.
The cash flow statement on the other hand recognizes the time value of money. Probably, itís the most conservative way of looking at business. Look how BPCLís growing debt burden is in fact due to burgeoning receivables.
| (figures in Rs m)
|Current Ratio (x)
The above table would indicate that Oil Co-ordination Committee (OCC) receivables are putting a strain on the companyís balance sheet, which can in no way be reflected through the income statement of the company. It is only when the investor looks at the cash flow position does he realize that the situation is strenuous (for no fault on the companyís part). In this case, the income statement of BPCL thus ignores time value of money. Had the OCC receivables been on time, the interest cost of the company would have been considerably lower.
Difference in Accounting policies:† An income statement could be distorted depending on the nature of accounting policy, which the company follows. A typical example of the same could be the difference in accounting policies for right off of expenses on content creation (intangible assets). The treatment of the same ranges from company to company. A extremely conservative company may write off the entire expense on software creation in the same year while others may write it off over the useful shelf life of the content, may well be even ten years. Now, other things remaining constant the income statement of the company, which writes off expenses over a longer period, appear better.
Financial Management:† A cash flow statement not only provides a snapshot of the companyís operational performance but also its financial management and utilization of scarce capital. While investment activities provide a birdís eye view of the treasury operations of the company, financing activities provide the financing tactics adopted. i.e the movement of cash from equity and debt.
Let us take example of Himachal Futuristic Communication Ltd.
|(figures in Rs m)
|Cash flow from Operations
|Cash flow from investing activities
|Cash flow from financing activities
|Net cash inflow/( outflow)
|Net profit as per income statement
The above table is self-explanatory. While net profit has grown by three digit rates year after year, cash from operations have not matched up with net profits. Secondly, inflows from financing activities (from issue of share capital) were utilized for investment activities (primarily as loans and advances).
Thus a cash flow statement is a mirror of not only the companyís profitability but also a reflection of the financial structure (including its liquidity and solvency) and the ability of the firm to adapt to the changing business scenario. Historical cash flow could also indicate the amount, timing and certainty of future cash flows. It therefore also offers comparability of operating performance of different enterprises because it eliminates the effects of using different accounting treatments for the same set of transactions and events.
More Views on News
Oct 13, 2015
Many people investing in a Ponzi scheme know what they are doing, but they still go ahead and make the mistake. Why?
Oct 12, 2015
When buying energy companies, Buffett does not focus on short term trends of oil prices.
Oct 12, 2015
Bill on his recent trip to Kudasi...
Oct 10, 2015
A technique that can protect your investments in stocks from the big losses that many investors see.
Oct 9, 2015
What the higher loan to value ratio for houses costing upto Rs 3 million means...
More Views on News
Oct 1, 2015
The CMD of HCC asked for a 300 basis points rate cut yesterday.
Oct 1, 2015
When investing in a business, should you bet on the Jockey or the Horse.
Oct 1, 2015
Asad Dossani discusses how options are more complicated than stocks or futures. But the complexity gives us better profit opportunities, and itís easier to make money with options
Oct 1, 2015
We often hear how important it is to start saving and investing to meet your financial goals, but little is said about selling investments.
Oct 1, 2015
When investing in a business, should you bet on the Jockey or the Horse
© Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement. LEGAL DISCLAIMER:
Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Use of the information herein is at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Before acting on any recommendation, investors should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here
. The performance data quoted represents past performance and does not guarantee future results.SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: 91-22-6143 4055. Fax: 91-22-2202 8550. Email: email@example.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407