Any accounts wizards in here?

[drew83]

I am writing an essay for an insurance exam. (glamorous I know!!!)

I have hit a question talking about annual profit, net cash outflow etc.

I'm confused.

If a company reports a £100m annual profit in 2014, but a net cash outflow of £75m in 2014 is this good or bad?

1) is net cash outflow what they spent / annual profit what they have made after all bills?
therefore -£75 + £100 = £25 net profit?

or

2)is annual profit what they have made in 2014, but after bills lost £75m? i.e £100 - £175 = -£75??

or

3) are they completely separate issues.

I am having a real mare with this question........

cheers all

 

[ventura]

Cash flows show where a company has spent its money during the year. Profits are basically sales less costs but the cash may not have changed hands by the year end due to credit terms taken.

Cash flows are generated by the profits made in the year but takes account of other spending which doesn't hit the profit and loss account. Payments of dividends, buying/selling fixed assets, repayment of bank loans etc.

In the above example £100m profits will be good (depending on the size of the company) but it depends where they've spent their money as to if a cash outflow is bad or not.

 

[drew83]

Ventura, thanks for this...

the question (shortened) is:

An insurer is evaluating a potential long term supplier of admin.

Supplier has expanded very quickly. heavily invested in IT equipment over last 3 years. Supplier reports annual profit of £100 in which marginally increased on 2013.

it's reported a net cash outflow of £75m in 2014.

I have to decide (based on above) if insurer should enter contract........

the joys of these essays!!

Insurance stuff I can do. this is just rubbish......the book I have to use is poorly written & I don't understand this side of things.

can you imagine you are talking to a 4 year old please?

 

[Canary_Yellow]

Profit is sales less costs in the period, regardless if whether cash is paid or received.

Cash flow is simply the bank balance of the company and in the short term not linked to profit.

Cash flow problems cause a lot of profitable business to fail. So profit and cash flow should be looked at independently.

If the company has invested in IT equipment and that's what caused the negative cash flow then that seems ok, but if the business is generally spending more cash than it brings in that's more of a problem.

In the long term, you'd expect profitable businesses to bring in lots of cash, but if they can't pay suppliers in the short term they're done for.

 

[ventura]

If the insurer is looking at a long term supplier then he would want a company that is reliable and aren't going to go out of business anytime soon leaving him without a supplier. Also one that can meet his supply needs without any problems.

He would need to consider why there has been a net cash outflow in the year and if this poses a risk.

The main point to look at would be how the company is funded. If they have a cash outflow of £75m in the year, was this money they had in the bank or do they have a lot of debt as a result?

A review of the annual accounts should breakdown how the cash flows have arisen and show the cash & borrowings in place.

If they have a lot of borrowings then there is a risk that they won't be able to repay the amounts due on time and get wound up by the lender. Leaving you without a supplier.

A lot has been spent on fixed assets (IT equipment) which would be a large cash outflow in one lump sum but not have as large an impact on profits. The assets would be depreciated (written off to the P&L) over their useful life (say 5 years so only 1/5th impact on profits each year) but all cash flows up front. If this was the sole cause of outflows I wouldn't see it as an issue if trading profitably and no issues regarding repayment of borrowings.

Given the information I don't think there is a definite answer to if they should enter the contract or not. Further details behind how the cash flows have arisen is needed.

 

[Canary_Yellow]

Looks sensible to me.

There's a saying, "cash is king". Businesses don't fail because they make losses, they fail because they run out of cash.

 

[drew83]

Cheers ventura.

That's all the info I have. I have to make my decision on that info.

Then part 2 identify other details I need to make a more fully informed decision. all a bit silly really! but that's explained it for me nicely!!

Thanks again!

 

[Deleted member 1147]

Cash is indeed King!

A good accountant can make a profitable company show a loss. It’s the aim if tax liability is to be reduced. Although of course you can’t pay as much out in dividends if profits are low.