Financial analysis - Case Study Example

There are various as to why a firm can be profitable and experience cash flow problems at the same time. This case study will discuss the reasons as to why the firm is experiencing cash problems and provide recommendations on how it can improve its cash flow. Cash flow is the ability of a company to meet its financial obligations. A negative cash flow prevents a company from meeting its debt payments like in the case of Cape Chemicals. It is important for Cape Chemicals to analyze the reasons leading to the negative cash flow while still reporting an increase in the profits.

By doing this, it will be able to lower its debt ratio to enable it acquire long term borrowing. The analysis will also be aimed at acquiring a positive cash flow and positive profits. Reasons for the negative cash flows at Cape Chemicals The profit for the company has increased significantly over the last three years due to the increase in the revenue obtained from the increase in sales of chemicals. The new product lines have led to increased production and hence increased sales and revenues.

However, despite of the increase in profit, the company has negative cash flow due to increase dependence of loans for its capital expenditure. This means that the cash obtained from the profits and other business income is used in capital expenditure. That is, the company uses all of its liquid cash to pay for loans used in capital expenditure leaving it with a negative cash flow. Cape Chemical is a company which deals with the distribution of dry and liquid chemicals. The main reason as to why the company is profitable but broke is because the company has been servicing loans or purchasing capital equipments.

Cape Chemicals has intensely used its cash flows to purchase capital equipments in its bid to add new product lines for the company. The need to increase the capacity of the company has seen the company use most of its cash to purchase new equipments a situation which has drained its cash flows. An additional chemical product line for the company requires a large sum of money which has drained the firm’s cash supplies. The company has also been serving loans (long term loans) which have been borrowed for the capital requirement reasons.

Cape Chemicals used to borrow for its capital requirement until 2006 when the company had reached its bank borrowing limit. The increased borrowing has led to an increase in the debt ratio of the company as shown below Debt ratio 2005 2006 2007 45.45% 58.4% 71.5% The increase in the debt ratio over the three year period is an indication of increase borrowing. The close the ratio is to 100%, the higher is the company depended on borrowings and loans making leading to increase in the total debts and a reduction in the total assets.

Capital expenditures are subject to depreciation which reduces the net income and subsequently the profitability of the company. The depreciation expenses associated with the capital expenditure of Cape Chemical therefore leads to the negative cash flow experienced in the company. Poor collections practice in the company is also responsible for the negative cash flow. For example, according to Stewart, the liberal credit policy in the company had led to increased accounts receivables which then led to the reduction in the