Cash Flow Analysis, Target Cost, Variable Cost PDF

Cash Flow Analysis
Cash flow differs from profit. Cash flow refers

to the money that flows in and out of your
business. Profit, however, is the money you
have after deducting your business
expenses from overall revenue.
What Is Cash Flow Analysis?
 There are three cash flow types that companies should track
and analyze to determine the liquidity and solvency of the
business: cash flow from operating activities, cash flow from
investing activities and cash flow from financing activities. All
three are included on a company’s cash flow statement.
 In conducting a cash flow analysis, businesses correlate line
items in those three cash flow categories to see where money is
coming in, and where it’s going out. From this, they can draw
conclusions about the current state of the business.
 Depending on the type of cash flow, bringing in money in isn’t
necessarily a good thing. And, spending money it isn’t
necessarily a bad thing.
Cash Flow Analysis Basics
Cash flow analysis first requires that a company generate cash
statements about operating cash flow, investing cash flow and
financing cash flow.
 Cash from operating activities represents cash received from
customers less the amount spent on operating expenses. In this
bucket are annual, recurring expenses such as salaries, utilities,
supplies and rent.
 Investing activities reflect funds spent on fixed assets and
financial instruments. These are long-term, or capital
investments, and include property, assets in a plant or the
purchase of stock or securities of another company.
 Financing cash flow is funding that comes from a company’s
owners, investors and creditors. It is classified as debt, equity
and dividend transactions on the cash flow statement.
Why Is Cash Flow Analysis
Important?
 A cash flow analysis determines a company’s working
capital—the amount of money available to run
business operations and complete transactions. That is
calculated as current assets (cash or near-cash assets,
like notes receivable) minus current liabilities (liabilities
due during the upcoming accounting period).
Preparing a Cash Flow Statement
Let’s first look at preparing the operating cash flow statement. The line
items that are factored into the company’s net income and are included
on the company’s operating cash flow statement include but are not
limited to:
• Cash received from sales of goods or services
• The purchase of inventory or supplies
• Employees’ wages and cash bonuses
• Payments to contractors
• Utility bills, rent or lease payments
• Interest paid on loans and other long-term debt and interest received
on loans
• Fines or cash settlements from lawsuits
There are two common methods used to calculate and prepare the
operating activities section of cash flow statements.
Cash Flow Analysis Example
 Net income adjusted for non-cash items such as depreciation
expenses and cash provided for operating assets and
liabilities. Using a free public template from the Small Business
Administration (SBA), let’s say Wild Bill’s Dog Trainers and Walkers
had a net income of $100,000 to start and generated additional
cash inflows of $220,000.
 As you can see in the spreadsheet, it spent $41,000 on operating
cash outflows like hiring an additional person, buying new
equipment for the dog park, paying taxes and more. The owner
paid some principal down on a loan and took a draw of $50,000 for
an ending cash balance of $127,200. Small changes in any of those
line items show the impact of hiring more people, paying more
taxes, buying more equipment and more to ensure the business has
a healthy balance sheet and doesn’t go “into the red.”
Wild Bill’s Dog Trainers and Walkers
Five Steps to Cash Flow Analysis
There are a few major items to look out for trends and outliers that can tell
you a lot about the health of the business.
 Aim for positive cash flow
When operating income exceeds net income, it’s a strong indicator of
a company’s ability to remain solvent and sustainably grow its operations.
 Be circumspect about positive cash flow
On the other hand, positive investing cash flow and negative
operating cash flow could signal problems. For example, it could indicate
a company is selling off assets to pay its operating expenses, which is not
always sustainable.
 Analyze your negative cash flow
When it comes to investing cash flow analysis, negative cash flow isn’t
necessarily a bad thing. It could mean the business is making investments
in property and equipment to make more products. A positive operating
cash flow and a negative investing cash flow could mean the company is
making money and spending it to grow.
 Calculate your free cash flow
What you have left after you pay for operating expenditures and
capital expenditures is free cash flow. This can be used to pay down
principal, interest, buy back stock or acquire another company.
 Operating cash flow margin builds trust
The operating cash flow margin ratio measures cash from
operating activities as a percentage of sales revenue in a given
period. A positive margin demonstrates profitability, efficiency and
earnings quality.
Cash flow analysis helps your finance team better manage cash inflow
and cash outflow, ensuring that there will be enough money to run
and grow the business.
SOURCE: https://www.netsuite.com/portal/resource/articles/financial-
management/cash-flow-analysis.shtml
Target Costing
Target costing was developed independently in both
USA and Japan in different time periods.Target costing
was adopted earlier by American companies to reduce
cost and improve productivity.
What is Target Costing?
Target costing is not just a method of costing, but rather
a management technique wherein prices are
determined by market conditions, taking into account
several factors, such as homogeneous products, level of
competition, no/low switching costs for the end
customer, etc. When these factors come into the
picture, management wants to control the costs, as they
have little or no control over the selling price.
Target Costing = Selling Price –
Profit Margin
Why Target Costing?
In industries such as FMCG (Fast Moving Consumer
Goods), construction, healthcare, and energy,
competition is so intense that prices are determined by
supply and demand in the market. Producers can’t
effectively control selling prices. They can only control, to
some extent, their costs, so management’s focus is on
influencing every component of product, service, or
operational costs.
The key objective of target costing is to enable
management to use proactive cost planning, cost
management, and cost reduction practices where costs
are planned and calculated early in the design and
development cycle, rather than during the later stages of
product development and production.
Key Features of Target Costing:
 The price of the product is determined by market conditions.
The company is a price taker rather than a price maker.
 The minimum required profit margin is already included in the
target selling price.
 It is part of management’s strategy to focus on cost reduction
and effective cost management.
 Product design, specifications, and customer expectations are
already built-in while formulating the total selling price.
 The difference between the current cost and the target cost is
the “cost reduction,” which management wants to achieve.
 A team is formed to integrate activities such as designing,
purchasing, manufacturing, marketing, etc., to find and
achieve the target cost.
Advantages of Target Costing:
 It shows management’s commitment to process improvements
and product innovation to gain competitive advantages.
 The product is created from the expectation of the customer
and, hence, the cost is also based on similar lines. Thus, the
customer feels more value is delivered.
 With the passage of time, the company’s operations improve
drastically, creating economies of scale.
 The company’s approach to designing and manufacturing
products becomes market-driven.
 New market opportunities can be converted into real savings
to achieve the best value for money rather than to simply
realize the lowest cost.
Example:
ABC Inc. is a big FMCG player that operates in a very
competitive market. It sells packaged food to end
customers. ABC can only charge $20 per unit. If the
company’s intended profit margin is 10% on the selling
price, calculate the target cost per unit.
Solution:
Target Profit Margin = 10% of 20 = $2 per unit
Target Cost = Selling Price – Profit Margin ($20 – $2)
Target Cost = $18 per unit
SOURCE:
https://corporatefinanceinstitute.com/resources/knowle
dge/accounting/target-costing/
Variable Cost
What Is a Variable Cost?
A variable cost is a corporate expense that changes in
proportion to how much a company produces or sells.
Variable costs increase or decrease depending on a
company's production or sales volume—they rise as
production increases and fall as production decreases.
Examples of variable costs include a manufacturing
company's costs of raw materials and packaging—or a
retail company's credit card transaction fees or shipping
expenses, which rise or fall with sales. A variable cost can
be contrasted with a fixed cost.
Understanding a Variable Cost
 The total expenses incurred by any business consist of
variable and fixed costs. Variable costs are
dependent on production output or sales. The
variable cost of production is a constant amount per
unit produced. As the volume of production and
output increases, variable costs will also increase.
Conversely, when fewer products are produced, the
variable costs associated with production will
consequently decrease.
How to Calculate Variable Costs
The total variable cost is simply the quantity of output

multiplied by the variable cost per unit of output:
Total Variable Cost = Total Quantity of Output X
Variable Cost Per Unit of Output
Example of a Variable Cost
Let’s assume that it costs a bakery $15 to make a cake—$5 for raw
materials such as sugar, milk, and flour, and $10 for the direct labor
involved in making one cake. The table below shows how the variable
costs change as the number of cakes baked vary.
As the production output of cakes increases, the bakery’s variable

costs also increase. When the bakery does not bake any cake, its
variable costs drop to zero.
What Are Some Examples of
Variable Costs?
Common examples of variable costs include costs of
goods sold (COGS), raw materials and inputs to
production, packaging, wages and commissions, and
certain utilities (for example, electricity or gas that
increases with production capacity).
Key Takeaways
 A variable cost is an expense that changes in
proportion to production output or sales.
 When production or sales increase, variable costs
increase; when production or sales decrease, variable
costs decrease.
 Variable costs stand in contrast to fixed costs, which
do not change in proportion to production or sales
volume.
SOURCE:
https://www.investopedia.com/terms/v/variablecost.asp

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Cash Flow Analysis

Cash flow differs from profit. Cash flow refers

The total variable cost is simply the quantity of output

As the production output of cakes increases, the bakery’s variable

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