Applying variance analysis to examine companies' operating cash flows

The purpose of this study is to examine companies' operating cash flows by using a cash flows variance analysis approach. Given the increasing importance of a company's operating cash flow position, useful tools will be needed to analyze cash flow of a business entity. The analytical model being applied in this study was originally proposed by Mr. John Hull, a faculty of Management at the University of Toronto, Canada. The approach being used is called cash variance analysis. It measures the impact of six factors on a company's net cash provided by operating activities. These six factors are previous year's operating profit plus depreciation, sales growth rate, the company profitability, the management of working capital, interest payments, and income taxes. Two sets of sample companies have been picked from the pharmaceutical industry. Ten of them are so-called "profit" companies, while the other ten have been named as "loss" companies. The "profit" group distinguishes from the "loss" group by their sizes, net sales and net income figures. Most of the firms in the "profit" group have total assets of about $4,000 million, net sales of about $3,500 million, and net income after tax figures of about $700 million. On the other hand, most of the companies in the "loss" group have total assets of about $240 million, net sales of about $140 million, and net income after tax figures of about $2.5 million. Individual cash flow variance analysis was done for each of the sample company. By examining the operating cash flow situation of these companies, we can see if the "profit" group performs better in this area (generating cash flow) than the "loss" group. That is, the "profit" sample companies should have higher net cash provided by operating activities figures, and more positive cash variances than the "loss" sample companies. The result of the study does express the above phenomenon. Given the sizes, sales volume, and profit level, the "profit" group does perform better than the "loss" group in terms of generating operating cash flows. Also, recommendations have been made regarding the sample companies' improvement on their operating cash flows. For both sample companies, control should be imposed on the increase of their receivables and SGA (Selling, General, and Administrative Expenses). These two items bring adverse effect on a company's operating cash flows. In addition, the "loss" sample companies should increase their sales level and find ways to manage their inventory properly for the sake of their operating cash flow. Finally, through this study, the usefulness and applicability of the proposed model has been verified. It's really an objective way to learn more about a company's cash flow situation.