Why Cash Flow Analysis is Important - Pt. 3

In the second part of the article we outlined the essential features of the Financial Statement, a fundamentally important tool for keeping the dynamics of company liquidity under control in a simple but effective way.

In fact, due to the way it is constructed, the Statement is able to provide us with a whole series of valuable information regarding how (and where, in which macro-areas) the company was able to create or absorb liquidity.

Let us imagine, for example, 5 companies, which at the end of year t–1 all have liquid assets equal to 1,500, which become (for all) 2,500 in year t .

All 5 companies, therefore, generated cash of 1,000 during year t .

All as summarized in the following table:

If we judge the 5 companies considering only the quantitative level, the cash flow generated during the year, they all would seem to have performed in the same way, creating cash flow for 1,000.

However, upon closer inspection, there are significant differences between one company and another.

Let's see them together!

The VIRTUOSA company, thanks to its core business, has produced liquidity for 10,000 with which it was able to not only finance significant investments in new machinery for 7,000, but also reduce debt (or distribute dividends, the concept is the same) for 2,000. The remaining 1,000 went to increase the initial liquidity, which during the financial year thus went from 1,500 to 2,500.

The company SANA , thanks to its typical activity, generated liquidity for 7,000 with which it was able to finance 70% of significant investments in new machinery (which cost a total of 10,000). The remaining 30% of the new machinery was paid for by resorting to a new loan for 4,000. The part of the loan that remained unused increased the initial liquidity, which also this time went from 1,500 to 2,500. Compared to the previous case, this company, although healthy, is still forced to increase its debt, with a consequent increase in terms of passive interests .

The BISOGNOSA company, thanks to its operating activity alone, produced liquidity for 3,000 with which it was able to finance only 30% of significant investments in new machinery (which cost a total of 10,000). To finance the remaining 70% of the new machinery, it was forced to go into debt for a good 8,000. The part of the financing that remained unused increased the initial liquidity, which as we know went from 1,500 to 2,500. Compared to the previous case, this company will find itself having to pay even higher passive interests in the future .

STATICA was unable to generate liquidity with its core business. The cash burned with business operations was equal to 2,000. Furthermore, while waiting to understand how to move to get out of this difficult situation, it did not make any new investments . The company, strong (still for a little while!) in its past fame, still managed to get into debt for 3,000, thus managing to plug the absorption of liquidity caused by operational management. The part of the financing that remained unused went to increase the initial liquidity, which also this time went from 1,500 and 2,500. Compared to the previous case, the company will find itself having to pay passive interests in the future, probably lower; however, in addition to the serious problem of the low liquidity generated by operational activity, it could also have serious difficulties in terms of production capacity, since it did not make investments .

The CRITICA company with its operational activity has burned cash for 6,000. The situation is definitely compromised and the company has not been able to find support from the banks or from the shareholders themselves. Therefore, to meet the cash needs it was forced to divest , selling a significant part of its machinery (7,000) to obtain liquidity. Even in this last case, the part of the disinvestment that remained unused has increased the initial liquidity, which as usual went from 1,500 to 2,500. Compared to previous cases, this time, in the absence of significant strategies, the continuation of the activity is highly at risk: the disposal of machinery has reduced the already compromised production capacity, which in the future can only further worsen the ability of the operational management to generate cash, with consequent further deterioration of the general conditions of the company.

These examples, although intentionally exaggerated to facilitate the exposition, demonstrate how important it is for the entrepreneur to stop sailing by sight and immediately undertake a path of consultancy and support that will lead him to a greater awareness of his company's numbers, but without always waiting until the last moment , when things start to take a worrying turn, and taking the helm of the company for any corrective maneuvers then becomes really complicated.