ANALYZING FINANCIAL STATEMENTS TO MEASURE THE FINANCIAL PERFORMANCE OF A BUSINESS ENTITY 1 MT480M1 1 Analyze Financial Statements to Measure the Financial Performance of a Business Entity Purdue Global University Karl Richland Chief Financial Officer Semtell Company Cincinnati Ohio Part 1 Business Letter The business letter explains the reasons that cause negative cash flows despite increasing sales The information reviews all possible scenarios based on research and evaluation of the company s financial statements The management should review the information and incorporate ANALYZING FINANCIAL STATEMENTS TO MEASURE THE FINANCIAL PERFORMANCE OF A BUSINESS ENTITY 2 it in decision making to enhance the profitability of the company and maintain positive cash flow to enable payment of vendors within 30 days Why cash can go down even when sales are up Cash flows decrease despite increasing sales because of the following reasons Investing in profitable activities that do not result in positive cash flows High amounts paid to vendors utility payments and miscellaneous expenses Increased short term and long term liabilities Higher cash outflows than cash inflows The first reason implies that the organization invests heavily in activities that do not culminate in positive cash flows such as credit sales Soboleva et al 2018 Credit sales imply that the company sells its products and services to clients on credit terms As a result the company does not generate sufficient cash flows to sustain its operational activities including payment of vendors Further the organization spends its cash reserves to finance its operational obligations which results in dwindling cash flows despite increasing sales Therefore the management should lower investments in activities that do not result in positive cash flows such as credit sales Conversely the management should increase investments in non credit sales and maintain positive sales volumes profitability and cash flow momentum The second reason that results in dwindling cash flows in the organization is high amounts paid to vendors utility payments and miscellaneous expenses Soboleva et al 2018 ANALYZING FINANCIAL STATEMENTS TO MEASURE THE FINANCIAL PERFORMANCE OF A BUSINESS ENTITY 3 The organization should lower amounts paid to vendors by negotiating prices that will sustain its profitability and cash flows The company should partner with suppliers and vendors with low reasonable bargaining power to minimize cases of conflict of interests that culminate in litigations and revocations of business contracts Further the company should lower the cost of utility payments such as power and water An effective alternative in minimizing operational costs emanating from utility payments is the adoption of green and renewable energy The organization should also adopt non pollutant policies and integrate reusable recyclable and biodegradable materials Renewable and green energy enable the company to lower its energy costs which contributes a significant proportion of its expenses Additionally the adoption of renewable and green energy also enhances the attractiveness of the firm to investors which results in a large capital outlay to fund its research and innovation plans The use of reusable recyclable and biodegradable packaging materials not only increases the profitability of the company but also contributed to positive corporate social responsibility impact on the environment Non pollutant policies and environmental conservation enable the company to capitalize on globalization opportunities and generate additional cash flows accruing from increased business operations and investments The third reason that results in negative cash flows in the organization is an increase in short term and long term liabilities Soboleva et al 2018 The company should adopt alternative ways of raising capital instead of loans and credit facilities The firms should also ANALYZING FINANCIAL STATEMENTS TO MEASURE THE FINANCIAL PERFORMANCE OF A BUSINESS ENTITY 4 acquire its long term assets by settling cash payments because deferred payments lower the company s cash flows owing to increased interest payments The fourth reason that results in low cash flows in the organization is activities that result in higher cash outflows than cash inflows The management should review its cash management plans and institute remedial measures and interventions to minimize wastage The company should also institute prudent mechanisms for utilizing organizational resources and diversify the business portfolio company How increases in accounts receivables and inventory balances affect cash flows within a Account receivables are balances that the organization is yet to receive from customers after delivering products and offering services Adusei 2017 Some services that result in accrued account receivables include delivery of consignments financial training and global trade among others Account receivables affect the company s cash flows in the following ways Accrued account receivables result in a proportionate decrease in cash flows because the organization has not received payment of its products and services Adusei 2017 Conversely a decline in account receivables results in increased cash flows which enables the company to initiate prompt payments for its vendors Therefore the management should minimize account receivables by initiating transactions that culminate in prompt payments ANALYZING FINANCIAL STATEMENTS TO MEASURE THE FINANCIAL PERFORMANCE OF A BUSINESS ENTITY 5 Similarly an increase in inventory results in a decrease in cash flows and a decrease in inventory results in increased cash flows Business inventory involves its assets which the firm intends to sell Increasing inventory makes it difficult to liquidate the assets resulting in dwindling cash flows On the other hand a reduction in inventory makes it easy for the company to sell the assets and acquire much needed cash for routine payments Therefore the management should make interventions that culminate in a reduction of inventory and account receivables to increase cash flows What effect increases or decreases in asset and liability accounts have on cash flow As aforementioned increasing assets results in a proportionate decrease in cash flows because of difficulties emanating from liquidating the assets However an increase or decrease in liabilities will cause an opposite effect on the organization s cash flows Increasing