What is the Purpose of Cash Flow and How to Gauge the Financial Goals of the Firm

Financial Goals - Complete Controller

The cash flow of a firm is comprised of many facets, including cash raised from investors when they inject more capital, loan subordination, or selling of financial assets such as bonds, shares, stocks, and warrants. Cash flow can also refer to investments from tangible assets like operations-generated cash and intangible assets like a brand name or trade name. In essence, the sales are deduced through working capital charges, including how many products were sold, the cost of goods sold, the operating expenses, and operating income. While calculating cash flow, it is important that we include the non-expense amount back into the net profit so we can see how much cash was generated. Check out America's Best Bookkeepers

Regarding operating needs, it is vital to remember that an increase in accounts receivable and inventory is a decrease in cash and needs to be deducted. To put it simply, this is a cash outflow. Simultaneously, an increase in accounts payable is an increase in cash inflow. This is how the working capital cycle is assessed in a cash-flow statement.

The finance manager must match the cash flows in accordance with repayment of financial obligations, which typically include loan payments along with interest. On the other hand, it is at the discretion of upper management to determine how the investment is paid out, either in terms of dividend payments or capital gains.

Regarding tangible and intangible assets, valuation is ascertained by cash flows since it incorporates both the traits of the time value of money and risk premium. The approach of valuation of assets, usually adopted by finance managers, is by matching principle since Current Assets should always be financed through Current Liabilities. If cash flow is managed effectively by incorporating the elements of time and risk, it is easy to evaluate the price of any type of asset to be traded at the prevalent market price.

In a free market, the valuation of the asset can be ascertained through demand and supply.

Financial Goals of the Firm

All firms strive to increase their profits, lower their expenses, and expand their market share. Let us look at these goals individually: Check out America's Best Bookkeepers

Maximize Profitability

A firm’s most foremost objective is to be profitable and invest any revenue. Ratios in determining the profit margin are one of the ways to evaluate how much cash an organization can deduct from its gross sales.

On a macro level, there are three primary ratios pertaining to profit margins:

Gross Profit Margin

In a profit and loss statement, the first ratio is the gross profit margin. In essence, the amount of sales incurred against the given expenses of Cost of Goods Sold (COGS) and adding the non-expense item such as depreciation and amortization. It tells us that how efficiently the company has optimized its inventory and raw material levels in the overall production process:

Gross Profit Margin = (Total Sales – COGS)/Total Sales Check out America's Best Bookkeepers

Operating Profit Margin

After we have calculated the gross profit, we want to determine the operational efficacy of the company. While calculating the Operating Profit Margin, we consider the operating expenses incurred during the given period. This ratio implies how efficiently the company has been operating. In addition, it also portrays the cost-beneficial steps that that management has taken.

Operating Profit Margin = Operating Profit/Total Sales

This ratio is also a means of evaluating the Operating Leverage of a company. Higher operating profit margins represent that the organization has taken effective measures to curtail waste and control unnecessary expenses like costs of spare parts and materials, payroll expenses, and administrative costs.

Net Profit Margin

After calculating the operating profit, it filters down to non-operating expenses, where we subtract the financial expense and taxes.  Operating Profit can also be termed as Earnings Before Interest and Taxes (EBIT). This is the last profitability margin, illustrating how productively the company is being managed.

Net Profit Margins = Net Profits after Taxes/Sales

Like all ratios, profitability margin ratios never reflect the true financial picture of the organization. They are merely relevant with respect to the appropriateness and precision of the financial numbers. It is meaningless if we do not compare it with the industry trends and the average number per month in the annual cycle of the business financial report.

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