Calculate Cash Flow To Creditors For Fy21

Calculating Cash Flow to Creditors for FY21: A Comprehensive Guide

Calculating cash flow to creditors, also known as cash flow to suppliers, is a crucial aspect of analyzing a company's financial health. It reveals the efficiency with which a company manages its short-term liabilities, specifically those related to trade payables. Understanding this metric provides valuable insights into a company's liquidity position and its relationship with its suppliers. This comprehensive guide will walk you through the process of calculating cash flow to creditors for the fiscal year 2021 (FY21), explaining the underlying concepts and providing practical examples.

Understanding Cash Flow to Creditors

Cash flow to creditors represents the net change in a company's short-term debt to its suppliers. A positive value indicates that the company paid off more to its creditors than it borrowed, suggesting strong financial health and efficient management of payable obligations. Conversely, a negative value indicates that the company increased its short-term debt to suppliers, possibly signaling liquidity problems or aggressive growth strategies.

Why is it Important?

Analyzing cash flow to creditors provides several key benefits:

• Liquidity Assessment: It directly reflects a company's ability to meet its short-term payment obligations. A consistent positive cash flow to creditors indicates strong liquidity.

• Supplier Relationship: It reveals the company's relationship with its suppliers. Consistent timely payments build trust and strengthen supplier relationships, potentially leading to better terms and conditions.

• Financial Health Indicator: It serves as a vital indicator of overall financial health alongside other cash flow metrics. Analyzing it in conjunction with other data provides a holistic picture.

• Creditworthiness: For creditors and investors, it's a crucial factor in assessing creditworthiness and investment potential. Strong cash flow to creditors suggests lower risk.

• Operational Efficiency: Consistent positive cash flow can signal efficient inventory management and procurement processes.

Calculating Cash Flow to Creditors: The Steps

Calculating cash flow to creditors involves analyzing the changes in the company's accounts payable (trade payables) from the balance sheet and the payments made to creditors from the statement of cash flows. While the exact presentation might vary slightly depending on the accounting standards followed (e.g., IFRS or GAAP), the fundamental principle remains the same.

Here’s a step-by-step approach:

1. Obtain the Balance Sheets: You'll need the balance sheets for the beginning and end of FY21. These balance sheets will show the accounts payable (trade payables) amounts at those two points in time.

2. Identify Accounts Payable: Locate the "Accounts Payable" (or a similar line item representing trade payables) on both balance sheets. Note down the values for the beginning and end of FY21.

3. Calculate the Change in Accounts Payable: Subtract the beginning balance of accounts payable from the ending balance. A positive number indicates an increase in accounts payable, and a negative number indicates a decrease.

   • Increase in Accounts Payable: Indicates that the company borrowed more from suppliers during FY21 than it repaid.

   • Decrease in Accounts Payable: Indicates that the company repaid more to suppliers than it borrowed during FY21.

4. Examine the Statement of Cash Flows: The statement of cash flows provides crucial information on the actual cash payments made to creditors during FY21. Look for a line item specifically related to payments to suppliers or cash paid for goods and services. This line item typically appears in the operating activities section.

5. Determine Cash Paid to Creditors: The value shown under this line item represents the cash outflow to suppliers during FY21.

6. Calculate Cash Flow to Creditors: The final calculation involves combining the change in accounts payable and the cash paid to creditors. The formula is:

   Cash Flow to Creditors = Cash Paid to Creditors - Change in Accounts Payable

   • If the Change in Accounts Payable is positive (increase): Subtract this positive value from the Cash Paid to Creditors.

   • If the Change in Accounts Payable is negative (decrease): Add this negative value (which will become a positive) to the Cash Paid to Creditors.

Example:

Let's assume the following figures for a hypothetical company for FY21:

• Beginning Accounts Payable (FY20): $50,000
• Ending Accounts Payable (FY21): $70,000
• Cash Paid to Creditors (from statement of cash flows): $200,000

Calculation:

1. Change in Accounts Payable: $70,000 (Ending) - $50,000 (Beginning) = $20,000 (Increase)

2. Cash Flow to Creditors: $200,000 (Cash Paid) - $20,000 (Change in AP) = $180,000

In this example, the cash flow to creditors is $180,000. This signifies that the company paid $180,000 more to its creditors than the increase in its accounts payable.

Interpreting the Results: What Does it Mean?

The interpretation of cash flow to creditors depends on the context of the company's overall financial situation and industry benchmarks. A positive cash flow to creditors generally indicates favorable financial health and suggests:

• Efficient Management of Payables: The company is effectively managing its short-term debt obligations to suppliers.

• Strong Liquidity Position: The company has sufficient cash to meet its payment obligations.

• Good Supplier Relationships: The company maintains positive relations with suppliers based on consistent timely payments.

A negative cash flow to creditors, on the other hand, might suggest:

• Liquidity Issues: The company is struggling to meet its payment obligations to suppliers, potentially due to cash flow problems.

• Aggressive Growth: The company may be rapidly expanding operations and utilizing supplier credit to finance growth. While not necessarily negative, this warrants careful investigation.

• Potential Supply Chain Problems: Delays in payments could indicate problems in the supply chain or disputes with suppliers.

• Poor Financial Management: Consistent negative cash flow to creditors could indicate a lack of discipline in managing payable obligations.

Important Considerations:

• Industry Benchmarks: Compare the cash flow to creditors with industry averages. What might be considered a good or bad value in one industry may be different in another.

• Company-Specific Factors: Consider company-specific factors like seasonal fluctuations, one-time payments, and any significant changes in supplier relationships.

• Trend Analysis: Analyze the cash flow to creditors over several years to identify trends and understand the company's long-term financial health. A consistent positive or negative trend provides a more reliable indication than a single year’s data.

Advanced Analysis and Related Metrics

The analysis of cash flow to creditors can be enhanced by considering its relationship with other financial metrics. For example:

• Days Payable Outstanding (DPO): This metric measures the average number of days it takes a company to pay its suppliers. A high DPO might suggest that a company is stretching its payments beyond usual terms, potentially impacting supplier relationships.

• Working Capital Management: Analyzing cash flow to creditors in conjunction with other working capital metrics such as inventory turnover and accounts receivable turnover provides a comprehensive view of the company's efficiency in managing its current assets and liabilities.

• Operating Cash Flow: Comparing cash flow to creditors with operating cash flow helps assess whether the company's operations generate sufficient cash to cover its payments to suppliers. A significantly larger operating cash flow than cash flow to creditors suggests robust cash generation capabilities.

• Debt-to-Equity Ratio: Combining this ratio with cash flow to creditors gives insights into how much reliance the company places on supplier financing (accounts payable) in relation to its overall capital structure.

• Profitability Ratios: Analyzing profitability metrics alongside cash flow to creditors allows you to determine if the company's profitability translates into timely payments to suppliers.

Conclusion

Calculating cash flow to creditors is a valuable tool for assessing a company's financial health, liquidity position, and management of its relationships with suppliers. By meticulously following the steps outlined above and interpreting the results in the context of other financial metrics and industry benchmarks, you can gain a comprehensive understanding of the company's ability to manage its short-term debt obligations. Remember to always perform a trend analysis over several years to get a clear picture. This detailed analysis empowers stakeholders to make informed decisions and contributes to sound financial planning.