1. Two key aspects of financial planning are cash
planning and profit planning. Cash planning involves the
preparation of the cash budget and profit planning involves
preparation of pro forma statements. To make cash budget and
pro forma statements for a firm, accounting knowledge is
needed. Do accounting courses you took before help you better
understand how to make cash budget and pro forma income statement
and balance sheet? Explain.
2. "Cash is king" is an old saying in finance. A
firm's cash flow is different from its profit. Why does
finance care more about the cash flow than the profit? If a
firm has the positive earnings but has the negative free cash flow,
what does this signal indicate?
1. Both the aspects i.e. Cash budgets as well as Proforma statements are done to do financial planning. Cash Budgets are prepared to see how much of cash is flowing and where it is flowing i.e. Inflow and outflow. So that cash can planned beforehand and it doesn't fall short at any point of time and the surplus cash can be invested at all point because idle cash is a cost to the company while proforma Statements are prepared to check the viability and profitability of the company i.e. Whether the company is profitable with the operations it is running. So that it help the company with the scaling and operating decisions.
The Accounting courses for sure helps in understanding the preparation of the cash budgets as well as the preparation of the Income statement and Balance sheet. Its not simple to prepare these statements. Specialized expertise is required.
2. Cash defines the overall fiscal health of the company. Profits are different from the Cash generated by the company. For instance, there are lots of Company which are making huge losses but still these companies are still valued in Billions (Uber is one example). This phrase is used in the investment world. To evaluate whether to invest in a company or not, most investors looks for cash generating companies even if they are making losses in the initial stages because cash determines the survival of the company and the valuation of the company. That's why finance care more about the cash flows than the profits.
Now, positive profits with negative cash flows can be because of many reasons: -
i) More of credit sales than the cash sales. ( This increases the profits but does not increase cash)
ii) Huge investments in Plant and machinery. ( Only depreciation is charged in the income statement but huge outflow in cash statements)
iii) Loan repayments. ( only interest is debited in the income statement but huge outflow in cash statement)
So, positive income with negative cash indicates that the company has hugely invested in the Machinery or has paid huge amount of loans or the company is operating on credit sale.
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