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Bonds and Cash Flow

written by: madel57•edited by: Linda Richter•updated: 9/8/2010

The cash flow statement is an important statement to be included in the financial reports because it will show the company's ability to pay its bills when due. We will discuss here how the investment or issuance of bonds affects the cash flow statement of the company.

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    What Is a Bond: Its Role in a Company's Stability


    In the company's latest meeting, Mr. Ayala reminded the other members of the board that in financing its latest expansion in California, the company used its $200,000 reserved for plant expansion. The remaining amount to be financed is funded by floating a bond which will mature in 20 years. He also said that a large amount of idle funds is invested in bonds as an assured investment for 15 years. He further said that it is a gamble to put all investors' money in one basket so the issuance of the $500,000 bonds which helps in financing the expansion is just a wise thing to do. Cash is not also concentrated in short term investments.

    The accountant was already instructed to render an analysis about the bond investment and bond issuance at the next meeting of the Board. The analysis is called comparison of bond investment income and bond interest expense. This will show if the company's interest income on the bond investment will be greater than the interest being paid for the liability. If it is the other way around, they will have to think all over again. What is a bond then? Bonds are issued by a corporation, a government, or any of its agencies in exchange for money borrowed. Bondholders are classified as creditors., planning for construction, by eieio1948 Many financial experts recommend the inclusion of bonds in investment portfolios. They play an important role in every country's economy. And in a company's reporting of cash flow, bonds are also important.

    Bonds provide a higher level of security compared to stocks. However, the returns the investor gets on bonds are lower. Thus, bonds are characterized with stability and security.

    A combination of stocks and bonds in your investment portfolio is recommended by every financial expert. As for the proportion of each of them, it all depends on the level of risk you are comfortable with. The more risk you are willing and able to take, the more stocks you should include. On the other hand, if you are not comfortable with taking risky investment initiatives, include more bonds in your portfolio.

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    How Will the Investment or Issuance of Bonds Affect the Company's Cash Flow?

    As stated above, bonds are investments which are assured with stability and security. They are good sources of inflows to stabilize the cash flow of the company. The manager will only have to be flexible in selecting bonds with their corresponding risks.

    On the other hand, if the company borrows funds by floating bonds, the company should be assured of net returns (compare interest income from the investment of bonds and the interest expense from the floating of bonds) or else it is not cost effective.

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    What Is Cash Flow and Its Objectives?

    We were talking about bonds and the cash flow statement being related: What is a cash flow, by the way? Let us take a look first into the office of the chairman of the board of directors of Ayala and Associates, Inc.:

    The cash flow statement was reviewed thoroughly by the accountant, Rosenda, before submitting one copy to the chairman of the board of directors at 10:00 a.m. The directors of the company will be discussing the submission of a loan application with one of the biggest banking institutions of the country and they want to make sure that there will be no problems in the liquidity side of the company.

    How important is this cash flow statement to the application of a bank loan?

    Financing institutions usually look at the cash flow statement to determine the company's solvency and liquidity.

    Solvency and liquidity should not be interchanged.

    1. Solvency means that there are more current assets than current liabilities. Current assets come in the form of cash, marketable securities, receivables, inventories, and prepayments, while current liabilities are those associated with trade payables. If the company has more current assets than current liabilities, it still has the ability to borrow more funding to finance its operations.

    2. Liquidity is more than counting the assets, such as how available are these current assets to pay obligations.

    These two things mentioned above are reflected in the cash flow statement and will be reviewed by creditors to determine the said ability of the company before granting loans.

    Please continue on Page 2 for more on Cash Flow & Bonds

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    Understand how bonds fit into a company's cash flow statement with this example of an imaginary company's finances. Cash flow, bonds, and stocks all have a role in a company's effective financial strategies.
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    Preparation of a Cash Flow Statement

    The preparation of a cash flow statement is quite complex in that there is a need to call your accountant to do it for you. But let us, dollars, by Leonardini take a look at how Rosenda, the accountant of Ayala and Associates, Inc., prepares her cash flow. Please take note how the issuance and investment of bonds affect the statement.

    Among the two kinds of cash flows (direct and indirect), the direct method is used by Rosenda because it is simpler.

    First, analyze what are the transactions of Ayala and group them. In preparing a cash flow, time period is emphasized. Ayala has four kinds of transactions:

    1. Operating - include those cash transactions that are involved directly with usual operations (selling, purchasing, expenses, other collections, and other disbursements.) Time period is January 1 to December 31, 2009.

    Cash receipts from customers: $3,000

    Cash paid to suppliers and employees ($2,000)

    Cash generated from operations (sum) $7,500

    Bond Interest expense paid ($2,000)

    Income taxes paid ($4,000)

    Use addition and subtraction:

    $3,000 + $7,500 - $2,000 - $2,000 - $4,000 = $2,500 Net cash flow from operating activities


    Note: Interest and income taxes paid are involved with operating activities. If they are involved with other activities, they are not included here.

    2. Next, group the investing activities:

    Bond investment ($100,000)

    Proceeds from the sale of equipment: $7,500

    Dividends received $3,000 (dividends here are from the investing activities)

    Compute: $100,000 - ($7,500 + $3,000) = ($89,500) Net cash flow from investing activities

    3. Group the financing activities cash transactions:

    Proceeds from Bond Issuance $500,000

    Dividends paid: ($2,500)

    Compute: $500,000 - 2,500 = $497,500 Net cash flow used in financing activities

    4. Other source of cash transactions:

    Net increase in cash and cash equivalents: $10,500

    Cash and cash equivalents, beginning of year $1,000

    Add: $10,500 + 1,000 = $11,500 Cash and cash equivalents, end of year

    Wikimedia commons, Revenues and expenses, by Wikimedia Foundation Adding the four net cash flows, the result will be $422,000

    Operating $2,500

    Investing ($89,500)

    Financing $497,500

    Cash, end of year $11,500

    Total Net Cash Ending Balance $422,000

    Note: Referring to the cash flow statement, bond interest expense and the investment of bonds reduce the net cash from operations and investing activities respectively because the company is cashing out money while there is an inflow of cash in borrowing. You can see when calculating cash flow, bonds have a huge role.

    In the cash flow statement of Ayala and Associates, $422,000 is reported to be the Net Cash Flow for the four sources.

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    How Will the Cash Flow Statement Maintain Financial Flexibility?

    The preparation of a cash flow statement is needed to determine the company's ability to pay obligations when due so how does the company maintain its financial stability?

    1. Maintain liquidity by:

    a. Strengthening opportunities for cash sales.

    b. Formulating effective collection policies for receivables.

    2. Use cash efficiently by:

    a. Reducing unnecessary costs and expenses.

    b. Analyzing properly the budget for expenditures.

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    Management Strategies for Ayala's Company Performance

    Mentioning some managerial tools used by Ayala, management is optimistic in reaching its target for the next year's operations. Aside from the above-mentioned strategies, management is keeping on its toes about other ways of getting ahead because it is a fact that the company is facing very stiff competition within the industry.

    Image Credits:, planning for construction, by eieio1948, dollars, by Leonardini

    Wikimedia Commons, Revenues and Expenses, by Wikimedia Foundation