Question

Explain how the information in the "net cash flow for the month" and "ending cash balance" line helps the company's financial manager in planning for the next six months.

Answer 1

To Understand the importance of "Net Cash Flow for the month" and "ending Cash Balance", first we should check what is cash flow and what impact it shows and how its interpretation helps in planning:

What is Cash Flow: Cash flow is a statement which gives details relative change in cash of organisation over a period of month. Herein this over a period means either one month or six month or a year. Relative change here means how or because of which transactions opening cash balance is resulting into closing cash balance.

As we know every organisation has to enter or execute into operating transactions to earn its revenue or income. In this generation of revenue organisation has to spend or pay money to use resources to earn money. So earning of cash from transaction and spent on transaction to earn gives changes in cash balances.

Categorically, we can define organisation transactions into three category:

a. Operating Transactions: Transactions entered to generate revenue.

b. Investing   Transactions: Transactions entered into investment activity.

c. Financial Transaction: Transaction entered into financing activity.

So in cash flow preparation all above type transactions which involve movement of cash either inflow or outflow are captured and added or subtracted to find change in opening balance of cash in hand and closing balance of cash in hand.

When "Net change in cash flow" is added or subtracted into opening cash balance, it gives us Ending Cash Balance". Any ending cash balance for a period becomes Opening Cash Balance of immediate next period, whether period is a month or six month or a year.

So close observation & use of cash flow gives finance manager areas wherein he needs to plan to have healthy cash flow and avoid "Cash Burn Position". For example Finance Manager can plan to improve DSO (Daily Sales Outstanding) rate by reviewing organisation credit policy and even he can renegotiate credit term with his suppliers and vendors to make improvement in cash position. Finance manager can give message to operating team to control expenses or help in improvement of cash sales instead of more credit sales.