Cash Flow and Management Analysis

11 November 2018

Financial statements are the only direct source for gauging a company’s financial performance – they tell the story about profitability, financial health, and the ability to pay obligations, including returning earnings to stockholders. One of the financial statements is the statement of cash flows which is a summary of the cash flows of a company during a period of time and the change in the cash balance. The focus of the statement is on cash inflows and outflows (Subramanyam, 2014). The statement of cash flows explains the changes in the cash balance as well as changes in other assets and liabilities on the balance sheet and shows why net income differs from the cash generated or used in routine business activities. It provides the user the stage of the company within its lifecycle or the strategy taken by management or even the success (and viability) of a company as a going concern. The purpose of the statement of cash flows is to trace the cash in the company: where it came from and where it went. This is done through the classification of operating, investing, and financing cash flows, and certain noncash activities also are disclosed. Management must carefully consider all available sources and uses of funds. Therefore, it is important to analyze the movement of cash within a company. This paper will examine the statement of cash flows of General Motors Company (GM) for fiscal year 2017, 2016 and 2015, using financial ratios to evaluate the performance and risk of the company.
Cash Flow and Cash Management
The statement of cash flows is important because it shows how much cash the company has actually generated. In contrast, the income statement includes non-cash revenues and expenses which are excluded on the statement of cash flows. Many companies show profits on the income statement but run into trouble later due to insufficient cash flows which may lead to filing bankruptcy. Cash flow analysis is an important element in the financial analysis process. It helps management identify the movement of cash inflow and outflow of the company. By enhancing cash flow management, companies position themselves to improve operational efficiency, better manage cost of capital, mitigate operational and financial risks, and improve shareholder value (Deloitte, n.d.).
The statement of cash flows is an integral part of financial reporting that links the costs reflected on the balance sheet and the expenses on the income statement together for a complete picture of a company’s financial health. There are three primary business activities reported on the statement of cash flows: operating, investing, and financing.
Cash Flow from Operating Activities
The income statement reports the success of a company in generating a profit from its operations. Operating activities are those arising from primary business activities. Revenues and expenses reported in the income statement usually generate or use cash, though the period in which revenue is earned or an expense is incurred may differ from the timing of the actual receipt or payment of cash, and some revenues and expenses do not involve cash. Receipts from cash sales, collections on receivables, and dividends and interest received on loans and investments, as well as cash payments to suppliers and employees and for operating expenses, interest, and income taxes are included in net operating cash flows. Cash flows arising from these activities are of great importance as they affect the liquidity and financial flexibility of the company.
91440172212000In the ordinary course of business, General Motors’ cash flow is generated by selling and buying products and services, including vehicles, parts, and components. Cash flows for all derivative financial instruments are classified in cash flows from operating activities. Net cash provided by operating activities has steadily been increasing since fiscal year 2014 although net income has been decreasing since fiscal year 2015.
(figures from General Motors Form 10-K 2017; personal calculations)
We see a significant change from 2017 to 2016 particularly with a loss of income from continuing operations of 96%.  This is due to the US tax reform legislation causing the reduction in the corporate tax rate from 35% to 21% creating a $7.3 billion offset and a $2 billion valuation allowance for the sale of the European Business (Opel/Vauxhall) which is reflected in the deferred income taxes.   Changes in working capital increased by 588% – accounts receivable and inventory decreased while accounts payable increased due to increased sales allowance payments.   Pension contributions decreased approximately 50% due to discretionary contributions of $2 billion made to their US hourly pension plan in the year end of 2016.  Depreciation expense has steadily increased over the last three years, although it is neither a source nor a use of cash.
For fiscal year 2017 the net cash provided by operating activities is higher than the net income by $17,000 million as there were items that decreased net income but did not use cash, specifically: depreciation and amortization of $12,261 are expenses not requiring a cash outlay; deferred income taxes of $10,880 are an expense that has no present cash payment; and a decrease in inventory implies that cost of sales are charged by reducing inventory levels rather than by making cash payments of $440 million. Also, some items generated operating cash inflow but did not enter into the determination of net income, specifically: the decrease in accounts receivable means that cash is collected beyond the amounts recognized as sales revenue in the income statement of $1,402 million.
General Motors’ net cash flow from operating activities generally improves when wholesale volumes increase and can drop sharply when sales volumes decrease. Working capital balances are subject to seasonal changes which generally impact cash flow. An example can be taken from the annual summer and December shutdown periods when inventories are at their lowest levels; however, payables continue to come due and be paid.
A cash flow analysis should include the calculation of the company’s cash flow adequacy ratio which measures the “ability to generate sufficient cash from operations to cover capital expenditures, investments in inventories, and cash dividends” (Subramanyam, 2014). The ratio is calculated using three years of cash from operations divided by three years of capital expenditures, inventory additions, and cash dividends. For General Motors, the cash flow adequacy ratio is:
$17328 + $16545 + $11978
($27633 + $29166 + $23032) + ($1350 + $320) + ($2233 + $2368 + $2242)
$45851 / $88344 = 0.52
A ratio of 1 or greater reflects satisfactory levels of cash source. General Motors’ cash flow adequacy ratio is 0.52 indicating that their internal cash sources are insufficient to maintain dividends and current operating growth levels.
Cash Flow from Investing Activities
Investing activities pertain to assets required and used by the company, such as plant assets, natural resources, and intangibles, as well as investments. Cash flows from investing activities include cash receipts and payments arising from the purchase or sale of these types of assets. Cash inflows and outflows as a result of these activities are reflected as capital expenditures and acquisitions in the investing section of the statement of cash flows.
(figures from General Motors Form 10-K 2017; personal calculations)
General Motors’ net cash flows from investing activities has been a negative amount each year; therefore, using more cash for investing activities than taking it in. This could be a healthy sign as they drive cash from operations back into the company to generate future profits. Overall, General Motors decreased the amount invested by 23% from 2016 to 2017; continuing to invest in PPE but with a 5% reduction from 2016 to 2017. Also, net cash used in investing activities decreased due to proceeds from the termination of leased vehicles increasing 160% from 2016 to 2017 and the increased collections and recoveries on retail finance receivables.
Cash Flow from Financing Activities
85150220789500Financing activities is the final section of the statement of cash flows and may be viewed as transactions involving the parties which provide resources to the business: the creditors and the owners. Transactions with the creditors include borrowing and repaying the principal amount of loans. Transactions with the owners include investments by the owners, distributions to the owners such as withdrawals and cash dividends, the purchase of treasury stock, and the retirement of outstanding stock.
(figures from General Motors Form 10-K 2017; personal calculations)
General Motors earned $12.5 billion from financing activities, in the form of repayment of loans or interest paid, dividend pay-out to shareholders, etc. There was a cash impact of ($3.51) billion due to buyback of GM shares. Proceeds from issuance of debt accounts for 56% whereas payments on debt accounts for 36%. The repurchase of stock increased 80% from 2016 to 2017 which increases the ownership of shareholders. Dividends have been paid rather consistently each year showing stability.
Free Cash Flow (FCF)
One of the most useful measures of cash flow is free cash flow because it includes all factors that contribute to changes in cash flow.  Thus, it is a prime indicator of the financial health of a company.  Also, investors may use it to calculate the amount of cash flow that may be available for distribution as dividends.
The general concept of free cash flow is to compile the net change in cash generated by company operations, less any cash paid for working capital requirements, fixed asset purchases, and dividends (MyAccountingCourse, 2018).
(figures from General Motors Form 10-K 2017; personal calculations)
A company may have positive free cash flow though it is not really a healthy organization on a long-term basis.  All of the following situations generate free cash flow, but they are not indicators of a healthy company:
Delaying the payment of accounts payable
Selling fixed assets or delaying fixed assets purchases
Reducing maintenance expenditures
Reducing marketing expenditures
In the above cases, management has certainly made more cash available, but doing so may have adversely affected the long-term viability of the company.
Another issue is that free cash flow can be altered by the rate of growth of a company.  If sales are declining, accounts receivable may probably be converted back into cash, which raises free cash flow (despite a declining company).  Conversely, increasing sales requires additional working capital, which reduces free cash flow. Positive FCF provides financial flexibility because the company isn’t relying on the capital markets to fund its expansion.  A company with negative FCF may have to take out loans or sell additional shares to keep things going; thus, becoming a risky proposition if the market becomes unsettled at a critical time for the company.  Negative FCF is not always a bad thing in itself, particularly when it is due to the company making investments.
General Motors’ operating cash flow has been increasing each year since 2014 while, recently, capital expenditures decreased 5% from 2016 to 2017 which caused free cash flow to decrease 18%. This is an indication that the company may not meet its obligations, will not be able to continue to operate at its current level, and may not have reserve cash to pay investors.
Profitability Analysis
Return on invested capital is important in the analysis of financial statements by assessing both risk and return. Return on invested capital refers to a company’s earnings relative to both the level and source of financing. It is a measure of a company’s success in using financing to generate profits, and is an excellent measure of operating performance.
A company’s main objective is to maximize profits. Profitability analysis is concerned with the evaluation of the overall efficiency and performance of a company. Profitability ratios help in the analysis of the operational health of the company for profit generation. If the company is able to generate profits as a result of its core operating activities, it is a sign of good operational health of a company.
There are two types of profitability ratios: margins (relationship between profit and sales) and returns (relationship between profit and investments). Margin ratios measure operating efficiency with a goal of reaching a certain level of sales with minimum costs. Return ratios measure how effectively a company’s management utilizes resources to generate revenue.
Gross Profit Margin
1531620231902000The gross profit margin indicates how efficiently the company uses its raw materials, labor, and manufacturing resources to generate profits. It is a financial metric used to determine a company’s operational health by revealing the amount of money left over from revenues after accounting for the cost of goods sold (COGS). The higher the value of the margin, the better it is for the company. The formula to calculate the gross profit margin is subtracting the COGS from total sales and dividing that number by total sales. The gross profit margin for the past three years for General Motors is as follows:

(figures from General Motors Form 10-K 2017 and Ford Motor Co Form 10-K 2017; personal calculations)
Both companies have a positive trend of increasing sales with Ford Motor coming out ahead of General Motors but their gross profit margin isn’t as strong as General Motors. To maintain efficiency, General Motors will continuously need to evaluate their pricing and cost structure, and improve on reducing costs/inventory.
Net Operating Profit Margin
1432560222631000Net operating profit margin (NOPAT) is used to measure a company’s pricing strategy and operating efficiency. It is a measurement of what proportion of the company’s revenue is remaining to pay the variable costs of production. The higher the margin, the more effective the company is in converting revenue into actual profit. A low profit margin indicates a low margin of safety and higher risk as a decline in sales will erase profits and result in net loss. The formula to calculate the profit margin is net operating profit after tax divided by sales.
(figures from General Motors Form 10-K 2017; personal calculations)
The operating margin of General Motors is trending upwards but is still low which indicates that the costs not directly related to production are high, and the company should find ways of reducing costs, such as overhead and administrative expenses and taxes. Management should strive to increase profits by building customer loyalty which increase sales and increase the efficiency in production.
Return on Net Operating Assets
Return on net operating assets (RNOA) is an indication of how profitable a company is based on the net assets that have been invested. This ratio lets management know how efficient they are at using the company’s assets to generate earnings. Because it focuses on operational areas, it can be a better indicator of long-term future growth rates of a company. The formula for RNOA is dividing NOPAT by NOA. Net operating profit after tax (NOPAT) is derived from (Sales — Operating expenses) × (1 – [Tax expense/Pretax profit]). Net operating assets (NOA) is equal to operating assets less operating liabilities.
The RNOA for General Motors is trending downward; they should strive for increasing net income which means increasing sales. General Motors has had significant restructuring and cost reduction to lower operating costs. Corporate income tax rate reduced from 35% to 21% due to the Tax Act signed into law late December 2017. General Motors’ income tax expense increased $7.3 billion due to the change in the tax rate. Overall, a higher RNOA is generally desirable.
Horizontal / Vertical Analysis
There are various techniques to transform financial information into forms more useful for analysis. One such technique is the horizontal and vertical analysis which analyzes year to year changes. They are both similar in nature in which each analysis involves comparing income statement and balance sheet items as a percentage of each account in dollars and percentage. The broader view is the horizontal analysis, and the narrow view is the vertical analysis. This technique is useful for external and internal users, such as management and accountants, who will analyze the significant changes and take the necessary action to resolve the problem.
The horizontal analysis computes the changes from the previous year to the current in percentages. It can help gauge a company’s potential by measuring its growth and/or its diminishment over time. Ideally, taking note of a company’s gross profits over the years is the key. It can display a steady progression which can be used to estimate growth. However, noting a company’s liabilities over time is important too. For example, assessing a company’s diminishment over time through their long-term liabilities.
The vertical analysis uses data from one year and expresses each item as a percentage of a base amount. For example, on the balance sheet, each entry for each of the three major categories of accounts (assets, liabilities, and equity) is represented as a proportion of the total account. The main advantage of the vertical analysis is that the balance sheets of companies of all sizes can easily be compared. It also makes it easy to see relative annual changes within one company.
The chart that follows contains both a vertical and horizontal analysis of the balance sheet for General Motors. The vertical analysis shows that a majority of the accounts have remained stable with the exception of GM financial receivables (increase), equipment on operating leases (increase), deferred income taxes (decrease), and long term debt of GM financial (increase).
Upon the completion of each of the different analyses performed on General Motors, the management team will be empowered in making positive business decisions to increase profitability and cash flow in the next fiscal year. General Motors’ adequacy ratio of 0.52 indicates the company has insufficient internal cash source to support dividend payments and current operational growth. Management should pay attention to those periods of downtime in sales that affect overall cash flow. A continuous decline in sales shows solvency distress that can cause disruption in business operations and profits.
Deloitte US. (n.d.). Strategies for optimizing your cash management. Retrieved from
Garcia, Madison. (2017, September 26). How to Improve the Return on Net Operating Assets. Bizfluent. Retrieved from
General Motors Company. (2018). 2017 10-K form. Retrieved from
MyAccountingCourse. (n.d.). Free Cash Flow. Retrieved from
Subramanyam, K. (2014). Financial Statement Analysis. (11th ed.) New York, NY: McGraw-Hill

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