A cash flow statement is a statement which explains the various sources from which the funds are raised and the uses to which these funds are put. Complementing the balance sheet and income statement, the cash flow statement (CFS), a mandatory part of a company’s financial reports since 1987, records the amounts of cash and cash equivalents entering and leaving a company. The CFS allows investors to understand how a company’s operations are running, where its money is coming from, and how it is being spent. Chapter 2.Structure of Cash Flow Statement The cash flow statement is distinct from the income statement and balance sheet because it does not include the amount of future incoming and outgoing cash that has been recorded on credit. Therefore, cash is not the same as net income, which, on the income statement and balance sheet, includes cash sales and sales made on credit. Cash flow is determined by looking at three components by which cash enters and leaves a company: core operations, investing and financing.
Measuring the cash inflows and outflows caused by core business operations, the operations component of cash flow reflects how much cash is generated from a company’s products or services. Generally, changes made in cash, accounts receivable, depreciation, inventory and accounts payable are reflected in cash from operations.
Changes in equipment, assets or investments relate to cash from investing. Usually cash changes from investing are a “cash out” item, because cash is used to buy new equipment, buildings or short-term assets such as marketable securities. However, when a company divests of an asset, the transaction is considered “cash in” for calculating cash from investing.
Changes in debt, loans or dividends are accounted for in cash from financing. Changes in cash from financing are “cash in” when capital is raised, and they’re “cash out” when dividends are paid. Thus, if a company issues a bond to the public, the company receives cash financing; however, when interest is paid to bondholders, the company is reducing its cash.
Chapter 3.Cash flow analysis -An Introduction
Cash flow analysis is the study of the cycle of your business’ cash inflows and outflows, with the purpose of maintaining an adequate cash flow for business, and to provide the basis for cash flow management. Cash flow analysis involves examining the components of business that affect cash flow, such as accounts receivable, inventory, accounts payable, and credit terms. By performing a cash flow analysis on these separate components, one is able to more easily identify cash flow problems and find ways to improve your cash flow. When planning the short- or long-term funding requirements of a business, it is more important to forecast the likely cash requirements than to project profitability. Whilst profit, the difference between sales and costs within a specified period, is a vital indicator of the performance of a business, the generation of a profit does not necessarily guarantee its development, or even the survival. Normally, the main sources of cash inflows to a business are receipts from sales, increases in bank loans, proceeds of share issues and asset disposals, and other income such as interest earned. Cash outflows include payments to suppliers and staff, capital and interest repayments for loans, dividends, taxation and capital expenditure, loans given.etc. Net cash flow is the difference between the inflows and outflows within a given period. A projected cumulative positive net cash flow over several periods highlights the capacity of a business to generate surplus cash and, conversely, a cumulative negative cash flow indicates the amount of additional cash required to sustain the business. Cash flow planning entails forecasting and tabulating all significant cash inflows relating to sales, new loans, interest received etc. and then analyzing in detail the timing of expected payments relating to suppliers, wages, other expenses, capital expenditure, loan repayments, dividends, tax, interest payments etc.. When this net cash flow is added to or subtracted from opening bank balances, any likely short-term bank funding requirements can be ascertained.
Chapter 4.Objectives of Cash Flow Analysis
Optimum Utilization of operating cash
Implementation of a sound cash flow analysis and management is based on rapid generation, efficient utilisation and effective conversion of its cash resources. Cash flow is a circle. The quantum and the speed of the flow can be regulated through prudent financial planning facilitating the running of business with the optimum cash balance. This can be achieved by making a proper analysis of operative cash cycle along with efficient management of working capital.
Cash forecasting is backbone of cash planning. It forewarns a business regarding expected cash problems, which it may encounter, thus assisting it to regulate further cash flow management. Lack of planning results in spasmodic cash flows. For any organisation, cash is the lifeblood that keeps it the business going .That is why, Cash Flow Analysis and its management has been gaining importance with organisations that view the services as a crucial part of their corporate strategies.
Managing the cost of cash
There is always an opportunity cost of maintaining excess cash balance.ie. if the firm is maintaining excess cash the it is missing the opportunities of investing these funds in a profitable manner. Similarly if the firm is facing shortage of cash, then it may be required to arrange funds on an emergency basis to appropriate any imbalances in the cash flow. Therefore, cash flow analysis help in determining the appropriate cost of raising cash and the effective deployment of funds.
Chapter 5.Uses of Cash Flow Analysis
Cash flow analysis is used to evaluate the liquidity of a company, to find out ratios like the net present value and the internal rate of return, to act as a validating input for net income created by accrual accounting methods. A company can use a cash flow statement to predict future cash flow, which helps with matters in budgeting. For investors, the cash flow reflects a company’s financial health: basically, the more cash available for business operations, the better. However, this is not a hard and fast rule. Sometimes a negative cash flow results from a company’s growth strategy in the form of expanding its operations. By adjusting earnings, revenues, assets and liabilities, the investor can get a very clear picture of what some people consider the most important aspect of a company: how much cash it generates and, particularly, how much of that cash stems from core operations.
Chapter 6.Process of Cash Flow Analysis
I am working as a summer intern in the finance department of Motilal Oswal Securities Ltd. I am trained for managing the cash flow statement on a daily basis wherein the inflow and outflow of cash was managed and monitored. The different sources of funds with the respective uses are mentioned in brief. The process of cash flow analysis is described below. Initially we obtain the funds position by identification of sources of cash (funds) as follows:
Issue of Commercial papers and Non-Convertible debentures
Motilal Oswal Financial Services (MOFSL), the parent company as well as Motilal Oswal Securities Ltd, the broking arm, issue Commercial Papers and Non Convertible Debentures during appropriate market timings. These securities assist in the arrangement of funds required for funding the capital and revenue expenditure, working capital requirements and supplementing the growth operations of the company. The process of issuance and the corresponding co-ordination with NSDL , IPA ( Issuing and paying Agent), banks and subscribers is looked after by the respective department and the information of the funds availed is known and communicated while preparing the cash flow statement. We, thus, include the amount as an inflow of funds.
Balances in Client Settlement accounts and own accounts with the banks, Fixed Deposits, Loan against shares, ODs, Bank Guarantees, Short Term loans
The company maintains different kinds of accounts for different segments like NSE Cash segment, Own and Client Settlement Account and NCDEX Settlement Account for Commodities, NSE Futures and Options Client and Settlement accounts, BSE Client Account and settlement with different banks. These accounts facilitate effective coordination of funds obtained from the clients from the corresponding exchange as well as the company’s own funds traded over the exchange. The firm’s own funds as well as the client’s funds are available for optimum utilization at the consent of the client. Thereby these funds are reflected as an inflow in the cash flow statement. Loan facilities are provided by the banks for adequate working capital requirements especially during immediate need of funds when during the days of high market trading considerable requirement of margins in the form of cash needs to be parked in the exchanges. The concept of margins is explained further. Thereby funds available by these means are employed for further usage. Banks also provide non fund based facilities in the form of Bank Guarantees: A bank guarantee is an irrevocable commitment by the issuing bank to make a payment, at the request of its client, to the beneficiary specified in the bank guarantee, subject to the beneficiary filing a request with the bank to that end, and the fulfilment of the terms and conditions of such bank guarantee (conditional bank guarantee); before the expiry date of the guarantee and up to the amount specified therein. By issuing an unconditional bank guarantee, a new legal relationship is established, which is independent from the underlying transaction, whereby the issuing bank’s payment obligation arises subject to the beneficiary requesting such payment, irrespectively of any disagreements the parties may have regarding the fulfilment of the underlying transaction; i.e. the payment obligation arises at the time of the first call and without the need to assess the nature of the legal relationship. For availing bank guarantee, the banks require authorised letters stamped and delivered with the necessary certificates of creditability as a part of their documentation formalities. Usually the amount of Bank guarantee (BG) is availed against different collaterals like corporate guarantee and /or personal guarantees provided by the promoters to the extent of certain percentage and the remaining in the form of fixed deposits placed with bank, shares pledged of the value after haircut of 50% .Different banks have different specifications. There exists a BG commission for usage of the bank guarantee around 1.5-5% of the amount availed as BG as against the creditability of the company in the industry .BG commission is charged upfront with the issuance, and the charge is amortised over the period of the BG. Also facility of Loan against shares (LAS) is available where loans can be availed against the pledged value of the shares owned by the firm. Overdrafts (OD) are available for working capital requirements and are charged for the period of use of OD amount. They are also availed against fixed deposits placed by the bank and any shares pledged with the bank for the same. Similarly Short Term Loan facility is provided against the collateral of FDs, Shares, and Corporate Guarantee .They are majorly used for furnishing the margin requirements of the exchange. The CASH FLOW STATEMENT also shows the position of the bank accounts with the varied details discussed above .The picture below can give a fair idea about the daily status of funds with the banks. It shows the position of funds with bank on a particular day. It shows the funds in the different accounts along with the interbank and inter account transfers in the form of RTGS, investments and redemptions. The funds obtained or utilised by way of DVP trades, CP/NCD issuance, FDR placement and high value clearing are specified in the bank position statement. Also the exchange payin /payout for client settlements and collections obtained from the client accounts are shown; thereby the net position of the bank on a daily basis is ascertained. Client funds of Cash, F &O and settlement figures are bifurcated to give the exact position of the funds that are held on behalf of clients and the own funds ,that can be further utilised for revenue generation. Funds employed in the form of margins in the exchange in the respective segment are also shown. Similarly, positions for other banks are also prepared and mailed to the banks on a daily basis.
Interbank funds transfer
As mentioned earlier, the company has various accounts with different banks for different purpose. As and when the fund requirement arises from one account to another or from one bank account to fund another bank account during the business conducted in the day, the corresponding RTGS( Real Time Gross Settlement ) is undertaken and request are processed through faxing of letters containing the respective instructions. Some Banks also provide the facility of auto sweep wherein the funds are transferred into accounts where there is a shortfall from accounts having surplus funds. This ensures adequate funds for immediate deployment.
Money payout of funds invested in NSE and BSE: Capital segment and Futures and Options segment
The company’s own funds as well as those of the clients, when traded over the exchange into buying or selling of shares and other securities result in money payouts/payins and accordingly the funds available with the company increases or decreases. Particular files of communication of the same are updated from the exchanges on daily basis which assist in giving a true picture of the funds received or to be paid. They are thus updated in the cash flow statement. The settlement of Equities as prescribed by the exchange is on T+2 basis and Futures and Options on T+1 basis. Thereby the next day’s position of settlement with the clients and the exchanges is shown in the cash flow so as to ascertain the requirements of funds for the coming day .Accordingly the cash provisions can be planned out and money can be arranged on time. It is known as the Provision Payin/Payout for coming settlement day (Ledger Bal) – Day after tomorrow and these figures are obtained from the back office systems. They are thus updated in the cash flow statement.
Margin releases from the exchanges
As a stock broking firm, Motilal Oswal Securities have to arrange for appropriate margins in the exchanges for the dealing of its clients in different segments like equities, derivatives and commodities regularly. These margins can be in the form of Bank Guarantee, Fixed Deposits, Cash, Shares and Mutual Funds pledged with the exchange up to a certain proportion ( limit given by the exchange to any stock broking house).They act as a collateral in the event of any default of the payin of the company’s clients or the company itself as against the volume of trade conducted over the exchange. The CASH FLOW STATEMENT includes the average margins parked with the respective exchanges and the corresponding bifurcation of the margins in the form of Bank Guarantees, FDRs and cash. It also depicts the proportion of FDRs (Fixed Deposit Receipts) and shares pledged against the bank guarantees in the different banks. This is reflected in the pictures below. It helps in ascertaining the position of the application of the funds and helps in analysing the leverage obtained by way of borrowed funds. As the funds are released from the exchanges, they get available for further use the next day and can be invested or deployed appropriately. The following illustration gives a fair view of the margin statement. The margin report is updated on a daily basis by the concerned department and thus, the margin provisions and releases are updated in the cash flow statement. It gives a fair idea of the percent of total collateral parked with the exchange on a daily basis along with the funds actually utilised. Thus we can accordingly decide about the further deployment of funds in the exchange.
Loan availed from the holding company
As Motilal Oswal Securities stands as a subsidiary of the parent company, Motilal Oswal Financial Services Ltd, it is facilitated with easier loan provision facilities and funds can be availed from the parent company as and when required.
Redemption of Investments in Mutual Funds
As the cash flow statement is prepared, the surplus funds are invested in Liquid mutual Funds schemes of huge corpus funds and AUMs (asset under management).Cash is generated when funds that are invested are redeemed and the dividend accumulated thereon. This is generally processed on a daily basis whenever the surplus cash is ascertained. Liquid Mutual Funds enable easy liquidity coupled with less risk, as the risk is mitigated by investment into varied stocks of correlated returns by the asset management company. Arbitrage transactions Motilal Oswal Securities Ltd. has a particular department that analyses the revenues that can be made by way of arbitrage transactions. Different strategies are employed for taking advantage of the arbitrage opportunities in the capital and futures market. Generally the company deals in cash futures .Considerable profits can be booked while the deal involves less risk. The company makes revenues by way of capitalizing on the difference in the value of scrip of equity and futures over the period by employing a combination of different long and short strategies both in the cash market as well as futures market. The amount of revenue generated in the process is informed during the preparation of the cash flow statement. We thus update the amount while preparing the cash flow statement on a daily basis.
DVP Institutional releases
DVP known as DELIVERY VERSUS PAYMENTS arise when the company, on behalf of it Foreign Institutional Investors (FIIs) undertake the responsibility for provision of funds to the custodian bank of the FIIs when the buy or sell of the shares take place. Fund parked in with the custodian banks are released after the confirmation and are available with the company for utilisation. DVP is further elaborated in the outflow segment.
Information about the value of the trade conducted over the day and the amount accumulated is conveyed by way of collections obtained from the clients. Consolidated figures of each segment .i.e. NSE and BSE: Cash and F&O is electronically communicated by the respective department and the amount is updated in the cash flow as an inflow of funds available for further utilisation. This includes the brokerage earned. After obtaining the Funds availability position, the deployment of the cash is decided. For efficient and cost effective utilisation of the cash resources, the application sources are effectively analysed and the different requirements taken into consideration are as follows:
Provisions for salary, bonus, TDS, Advance Tax, Dividends, Operating Expenses
Salary and bonus, TDS, Advance Tax provisions, Dividends to the shareholders and the operating expenses for every month is calculated by the accounts section and the total figure is communicated for making the appropriate provisions as and when required. Thereby funds are provided for these revenue expenditure items.
Investments in Mutual funds ,fixed deposits, securities and derivatives
Funds available have to be put to best possible use .Most cost effective alternatives combined with least exposure to risks result in the majority of the investments in liquid mutual funds with no entry and exit load and a diversified risk approach. Easy liquidity supports daily investments and redemptions and thereby surplus funds in good proportions are invested in the liquid mutual fund of well rated firms like Reliance, ICICI, UTI and FORTIS Mutual Funds having huge corpus funds and considerable Assets under Management. Funds not needed daily can be locked in for a longer period with the banks in the form of fixed deposits with a better rate of return and can be further utilised in for availing bank guarantees and overdrafts against the fixed deposit receipts. As per the direction from senior authorities regarding investments in securities and derivatives, appropriate provisions are made in the cash flow statement and the funds are provided accordingly.
Loans availed from the holding company are repaid with the surplus funds available with the subsidiary company. Accordingly the provisions are made and the position of the net available funds is prepared with the cash flow statement.
Margin funding refers to the funding of the clients portfolio by the stock broking firm upto a certain percentage .It depends on the segment as to whether the client wants to deal in equity or derivatives .The amount of Margin funding depends on the creditability of the client and their relationship with the company over the period. A certain percentage of interest is charged for the purpose of margin funding. It facilitates easier availability of funds during bullish markets when the clients indulge in vast amount of trading and require funds in excess of their portfolio value. In order to provide for margin funding, appropriate provisions are made and accordingly the transfer of funds are processed by electronic funds transfer on a daily basis.
Funds are provided for the Deliver Versus Payment (DVP) transaction entered into, by the company’s trading unit. This comes under the institutional broking and distribution segment of the company. Thereby appropriate funds are reserved for funding DVP trades. DVP can be elaborated as follows: Monitored by RBI FII Governed by SEBI Guidelines CUSTODIAN BANK Indian Stock Exchange Stock Broker – MOSL The above sketch represents the Indian context where a FII is required to be registered with SEBI, RBI and also needs to have an agreement with a Local Custodian as per RBI, SEBI requirements. As per RBI the amounts brought in by FII and maintained in designated account is fully-repatriable outside India including the sales proceeds. It is also important to note that an FII cannot deal in any activity directly without a Custodian to honour its trades. FII registration and monitoring is one of the most cumbersome processes in the capital market today as the FDI cap is highly regulated in our country. In spite of such constraints too the business from this segment is the highest today as compared to historical statistics. Therefore Working capital requirements are visible for funding FII orders in the form of Exchange Margins and Pay-in towards stock exchanges.
Payments towards overdrafts, loans, BG commission
Provisions are made for payments of overdrafts availed through the banks and the repayment of loan against the shares pledged .Payments are effected through electronic transfer BG commission towards the bank guarantee facilities provided are paid on an average monthly basis. Accordingly provisions are made for the same in the cash flow statement and the outflow is reflected.
Funds available with the company include the deposits of the clients in their respective trading and settlement accounts with the company .As and when the net settlement takes place with the clients, the payouts are reflected and fund credited to the clients accounts. This is reflected as the outflow of funds in the cash flow statement.