Jan 29 2009
Generating Cash Flows for your Ongoing Operations - Operating Earnings
Companies need a certain amount of working capital to finance ongoing operations, take advantage of unexpected opportunities, and fulfill longer-run strategic plans. For Examples : payments to suppliers and scheduled payments to creditors and bondholders. Another example includes cash for plant expansion and for acquisition of other firms.
Companies manage this by preparing an annual master budget that forecasts operating needs, including any cash needs.
Beyond the cash budget objectives, there are value-adding considerations to cash flows, as well. Capital markets may perceive low levels of cash as a sign of a weak or risky firm. High levels may be seen as healthy. They can also be seen as a sign of poor investment management, or of managers misusing funds (i.e., an agency problem).
To finance ongoing operations, Companies can generate cash flows from a variety of sources, including:
1) Operating earnings (i.e., net income from sale of products or services)
Operating earnings, after payment of federal, foreign, and state or local taxes, add to retained earnings.
Earnings retained without a legitimate business purpose may be subject to special penalty taxes, such as the U.S. accumulated earnings tax.
Corporations should not be used to hold passive investments merely to take advantage of lower corporate marginal tax rates, and highly successful closely held corporations may have trouble if they accumulate large amounts of liquid assets and do not routinely pay dividends.
On next post, we’ll cover other source of financing.
