Understanding the flow of cash within an organization is critical to knowing the health of an organization. Without this understanding, a business may run into a situation where even though they are profitable, they may not have enough cash on hand to meet their obligations. This paper will look at the case study Eat at My Restaurant – Cash Flow (Gibson, 2013) and will analyze the difference between net cash provided by operating activities and net income and determine which a better indicator of long-term profitability is. It will then provide an analysis of the cash flow ratios for each of the firms contained in the case study. Finally, this paper will conclude with a determination of if one of the companies in the case study has a cash flow problem. Net Cash versus Net Income
Net income is derived from the Income Statement, which is based on the accrual method of accounting. Under the accrual method, revenue is recognized when earned and expenses are recognized when incurred. Net cash provided by operating activities uses the cash method of accounting where cash and expenses are recognized when received and paid. For example, under the accrual method, which net income is based on, a company would recognize revenue for services delivered based on the delivery of services instead of when a customer actually pays the invoice for these services. This is an important distinction because from an income perspective, the company will eventually receive that money, the company will not actually have that cash in-hand to pay expenses or make investments until receipt of payment from their customer.
This could create a situation where although the company looks profitable, in reality they cannot make their short-term commitments. When considering whether net cash provided by operating activities or net income is a better indicator of long-term profitability, the writer feels that the words “long-term” are critical to that decision. While net cash is critical to determine the ability of the organization to meet its immediate requirements, the non-cash factors that are included in the net income calculation portray a more accurate view of the long-term profitability. Also because of the timing differences between when revenue and expenses are recognized, the accrual method behind the net income model will produce visibility that is more accurate. For example, a month that produces low volume of sales and a high volume of receivable could produce a positive cash flow when in reality that low sales volume will negatively affect the subsequent months. This variance would be visible in the net income but would not be visible in net cash. Case Study Company Comparison
Yum Brands, Inc.
In the two years presented in the case study (2009-2010), Yum Brands, Inc. saw a significant decline in its operating cash flow/current maturities of long-term debt and current notes payable. This indicates that they are less able to meet their current debt obligation. However, when looking at operating cash flow/total debt, there is an increase of 7.3% showing that Yum Brands, Inc. is more able to cover its debt with operating cash. A review of the operating cash flow per share shows an increase of $1.14 showing an improvement in its ability to make capital expense decisions and pay dividends to its shareholders. Finally, Yum Brands, Inc. a .9 increase in operating cash flow/cash dividends. This shows that they are more able to pay dividends with its yearly operating cash. Panera Bread
During the same two-year period (2009-2010), Panera Bread did not have any long-term debt mature or have any current notes payable. They did however have 17.27% decrease in their ability to meet their total debt burden with operating cash. Panera Bread did show an increase of $0.74 in operating cash flow per share indicating an improved ability to make capital purchase decisions and pay dividends to its shareholders. Panera Bread did not make any dividend payments in either year. Starbucks
In 2009 and 2010, Starbuck also did not have any long-term debt mature or have any current notes payable. However, they did show a 7.94% increase in their operating cash flow/total debt ratio. This indicates an improved
ability to cover their total debt with operating cash flow. During this same period, Starbucks had an increase of $0.37 in operating cash flow per share indicating an improved ability to make capital purchase decisions and pay dividends to its shareholders. Although they did not pay any dividends in 2009, they did show an increase of 9.97 in operating cash flow/cash dividends in 2010. This shows that they are more able to pay dividends with yearly operating cash. Cash Flow Woes
While Panera Bread does show an increase of 28.5% in net income-including noncontrolling interest, they are only showing an increase of 10.6% in net cash provided by operating activities. This combined with a 17.27% decrease in their operating cash flow/total debt ratio could indicate potential challenges meeting debt. Furthermore, although Panera Bread does show an improvement of $0.74 in operating cash flow per share, they have not issued any dividends. This could indicate that Panera Bread is trying to invest in growth or potentially they are having difficulty meeting cash obligations. For these reasons, the writer believes Panera Bread may be experiencing a cash flow problem; however, a deeper look into their financial statements, balance sheets and cash flow statements over a broader timeframe would be required to assess their true position. Conclusion
Net Cash and Net Income are both critical elements allowing a view to the health of an organization. While it is imperative that a business has visibility to the cash available to pay debt, make investments, make capital purchases and pay its shareholders, it is equally important to have visibility to all revenue and expenses. While each tells their own story, in the end it is when used together that they bring the most value.
Gibson, C. H. (2013). Financial Reporting & Analysis. Mason: South-Western Cengage Learning.