Value of Cash Flows

By JR Maniego, RFP, CFA Level 1 Passer, CTP

In today’s economic and business environment, we often hear financial

chatter say that the main driver for consumer spending, low interest rates and
growth in the stock market is the abundant cash in the Philippine Financial System.
And little did we know, as ordinary people, that this amount of cash is the main
reason why our country has exhibited sustained recovery in light of the tremendous
impact of a global recession that has gripped the developed world for over 3 years
now. Hence, it is integral that we should realize the value of cash flows as we
become managers of businesses and our own personal finances.

According to popular economics, cash or money is used in several ways; as a

medium of exchange, a unit of account and a store of value. Money has been
around for some time and it has evolved through the years in different forms like
coins, bills, debit cards, smart cards or gift certificates which all possess the ability
to transfer and/or represent value. Despite the increase in financial innovative
practices like the use of credit cards, online and electronic payments; money still
remains an important building block of our economy. Money still possesses the
ability to move markets, control behavior and tilt sentiments. Today, Bangko Sentral
ng Pilipinas reported about over a trillion pesos worth of liquidity/cash circulating in
the Philippine financial system which has shielded our economy and our financial
markets from volatile asset price movements abroad. And because of these
evolving characteristics of cash flows, it has already joined revenue on the top of
financial importance and it is already considered as a driver for growth and value.

Looking at the profile of companies across industries doing better this year
are the companies that exhibit high cash flows in their financial statements. Holding
and subsidiary firms of the Sys, Ayalas, Pangilinans, Gokongweis and recently even
the Lopezes have shown tremendous cash balances and favorable net cash from
operations. Even for retail and individual investors, a proper balance of cash relative
to other personal assets bring flexibility to the decision making purposes for
personal investing and expenditure management.

Basically, the abundance of cash flows is an indication of the financial health

of a person and a business. And in troubled times, investors and decision makers
look to cash as one of the main deciding factors. On a financial perspective,
generated cash from operations gives you a peek into the core fundamentals of any
entity. It is an eye opener to your “true” financial health. It can help you easily spot
conditions of other important financial aspects like profitability, efficiency and
financial leverage.

1. Cash can lead to asset and liability efficiency.

It is a source of present and future financial health. It can be used as fuel to meet
current and long term needs. Efficiently managed firms can easily payoff costly
short term expenditures and direct excess cash flows into earning resources that
will give future benefit and value to shareholders. For individuals, a carefully
executed household cash management plan can give the family a much needed
vacation or a long overdue house renovation.

2. Cash can provide financial leverage.

It is also a financial leverage tool for businesses and individual. Banks, basically,
look at cash flows as an indicator of repayment capacity. By having favorable cash
results from operations or several sources of personal income, businesses and
individuals can borrow money for acquisition purposes and leave internally
generated cash to pay off working capital needs, pay dividends and other
investment opportunities.

3. Cash, a tax management tool.

It is also an indirect tool for tax management. By being leveraged, interest

payments will directly lower your annual taxable income; therefore exhibiting a
corruption-free and legal way of paying your right taxes. Kidding aside, may be
President Noynoy Aquino should craft favorable banking lending policies for small
businesses and in effect help increase tax revenue possibilities to manage the
looming budget deficit.

4. Cash is true profits.

Basically, earnings are intangible. It is something a firm or an individual cannot

touch. You cannot go to your vendor or to a mall saying I have millions of profits,
please supply me with raw materials or please feed my family 3 times a day. A firm
can never realize profitability and stock prices can never soar for long periods if
sales are not converted into cash. Huge firms like of Enron and Sunbeam are
among the many firms that turned belly up due to improper revenue manipulation/
practices for the very purpose of hiding low cash flow balances. For individuals, the
use of credit cards and spending money you do not have gives an individual a
perception of having more money; leaving you with debt.

Cash provides a lot of advantages but hording excessive amounts for periods
of time are also a disadvantage. For one, you are subjected to opportunity cost on
an alternative investment. Second, you lose to inflation. Rule of thumb is that you
hold cash to meet obligations for less than two years; the rest should be properly
invested. By holding excessive amounts of cash for more than 2 years, you lose Php
116,400 with a million cash holding.

The pros of holding cash out weight the cons. Firms and individuals need to
constantly practice a balancing act of “spending and saving” to realize its full
benefit. Always remember that the value that saving provides stops where savings
is not spent. So manage your cash wisely, put the right amount in short term
deposits, placements, treasury bills and financial products suitable for its intended
us; but in excess it is best you invest it somewhere else to realize its full potential.