Question

12. Below are summary cash flow statements for three roughly equal-sized companies. ($ millions) A B Net cash flows from operating activities (300) (300) 300 Net cash used in investing activities (900) (30) (90) Net cash from financing activities 1,200 210 (240) Cash balance at beginning of year 150 150 150 a. Calculate each company's cash balance at the end of the year. b. Explain what might cause company C's net cash from financing activities to be negative. c. Looking at companies A and B, which company would you prefer to own? Why? d. Is company C's cash flow statement cause for any concern on the part of C's management or shareholders? Why or why not?

Answer 1

a)

Cash Balance at the end of year = Cash Balance at the beginning of year + Cash Flows from all activities

Company A = 150-900-300+1200 = 150

Company B = 150-300-30+210 = 30

Company C = 150+300-90-240 = 120

b)

Possible Reasons for negative Cash Flow from Financing Activities are:

1) Repayment of Long Term Loans or Borrowings

2) Redemption of Debentures

3) Payment of Dividends

4) Share Buy Back

c)

Assumption 1: Both the companies are Startups, and there are very high chances of Growth

In this case, Company A would be better because its Cash Flow from Financing Activities is very high and from Investing Activities is highly negative, which means that, Company is aggressively Borrowing and Investing in new assets, which will result in rapid growth and higher profit when cashflow turns profitable.

Assumption 2: Both the companies are very old, products are at the end of the life cycle OR companies are in a bad condition.

In this case, Company B would be better because, it is not trying to infuse more money into losing business.

d)

Company C has positive Operating Cash Flow which is obviously not a concern.

Mild Negative Cash Flow from Investing activities means slow growth in Investments which is okay. It can't be regarded as a concern because company is harvesting good cashflows from operating activities.

Reasons for negative Cash Flow from Financing Activities are already mentioned above. All those are in FAVOUR of shareholders.

Therefore, There is NO concern.

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