cash flow analysis

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Cash Flow Analysis Nicole Mahfoud Estefania Rodriguez

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Page 1: Cash Flow Analysis

Cash Flow AnalysisNicole MahfoudEstefania Rodriguez

Page 2: Cash Flow Analysis

Cash Flow Analysis

An objective of financial analysis is to measure a company’s operating performance and financial condition.

Page 3: Cash Flow Analysis

Cash flow analysis

The choices available in the accrual accounting system make it difficult to compare companies' performances.

Cash flows provide the financial analyst with a way of transforming net income based on an accrual system for it to be compared easier.

Page 4: Cash Flow Analysis

Difficulties with measuring cash flows

The primary difficulty with measuring cash flow is that it is a flow: Cash flows into the company (cash inflows) and cash flow out of the company (cash outflows).

Page 5: Cash Flow Analysis

Difficulties with measuring cash flows

A simple method of calculating cash flow requires adding noncash expenses (for example, depreciation) to the reported net income amount to arrive at an approximation of cash flow, earning before depreciation and amortization, or EBDA.

EBDA = net income + Depreciation and amortization

Page 6: Cash Flow Analysis

The problem with this measure is that it ignores the many other sources and uses of cash during the period, cash that, for many companies, are significant.

Difficulties with measuring cash flows

Page 7: Cash Flow Analysis

Another estimate of cash flow that is simple to calculate is earnings before interest, taxes, depreciation, and amortization, EBITDA.

It is calculated:

EBITDA = Operating income, EBIT + interest expenses + depreciation and amortization

Difficulties with measuring cash flows

Page 8: Cash Flow Analysis

EBITDA is useful not only for its

simplicity, but because it allows us to

compare companies based on

operations, without considering how

companies choose to finance their

assets.

Difficulties with measuring cash flows

Page 9: Cash Flow Analysis

Cash Flows and Statement of cash flows

Over time, many companies began presenting information using the cash concept, which is a more detailed presentation of the cash flows provided by operations, investing and financing activities, which are the categories of cash flows.

Page 10: Cash Flow Analysis

The reporting company may report the cash flows from the operating activities on the statement cash flows using either the direct method (reporting all cash flow inflows and outflows) or the indirect method, starting with net income and making adjustments for depreciation and other noncash expenses and for changes in the working capital accounts.

Cash Flows and Statement of cash flows

Page 11: Cash Flow Analysis

The direct method provides more information about the sources of the company’s cash flows. Though it is recommended, but it is also the most difficult for the reporting company to prepare, as a result, most companies report cash flows from operations using the indirect method.

Cash Flows and Statement of cash flows

Page 12: Cash Flow Analysis

Looking at the relation among the three cash flows in a statement gives the analyst a sense of the activities of the company.

For example: A young, fast growing company may have Negative cash flows from operations But, Positive cash flows from financing

activities.

Cash Flows and Statement of cash flows

Page 13: Cash Flow Analysis

Free Cash Flows

Free cash flow (FCF), an alternative measure, was developed by Michael Jensen.

FCF is a measure of financial performance calculated as operating cash flow minus capital expenditures.

Page 14: Cash Flow Analysis

Free Cash flow is also known as Free cash flow to equity, FCFE.

FCFE = Cash flow from operations – capital expenditures. IF WE ADD AFTER TAX INTEREST: FCFF

FCFE + After tax interest = FCFF (Free cash floe to the firm. The theory of FCF was developed to explain

behaviors of the companies that could not be explained by existing economic theories.

Free Cash Flows

Page 15: Cash Flow Analysis

Calculating Free Cash Flow There is no correct method of calculating free cash

flow and different analyst may arrive at different

estimates of free cash flow for a company.

Because the amount of capital expenditures

necessary to maintain the business at its current

rate is generally not known.

Most analyst estimate free cash flow by assuming

that all capital expenditures are necessary for the

maintenance of the current growth of the company.

Page 16: Cash Flow Analysis

ExampleCah flow

from operations

$1,127

Deduct capital expenditures

412

Free cash flow

715

Cah flow from operations

$1,127

Deduct capital expenditures

412

Deduct dividends

150

Add proceeds from the sale of assets

34

Free cash flow from continuing operations

$599

This is an example of some of the variations that you will se in the free cash flow calculation. Because there is no one, right way to calculate free cash flow, for a given company you may see different values.

Page 17: Cash Flow Analysis

Net free cash flow Is a free cash flow less interest and other financing

costs, and taxes. In this approach, free cash flow is

defined as earnings before depreciation, interest and

taxes, less capital expenditures. Further, cash taxes

are deducted to arrive at net free cash flow.

The difference between NFCF and free cash flow

above is that:

The financing expenses- interest and, in some case

dividends- are deducted.

NFCF does NOT consider changes in working capital in

the analysis

Page 18: Cash Flow Analysis

Income tax expense

Deduct Increase in deferred income tax

Equals Cash taxes

EBIT

Add Depreciation and amortization

Equals Earning before interest, taxes, depreciation, and amortization

Deduct Capital expenditures

Equals Free cash flow

Deduct Interest

Deduct Cash taxes

Equals Net free cash flow

Deduct Cash common dividends

Equals Net cash flow

Page 19: Cash Flow Analysis

The usefulness of cash flows in financial analysis

An analysis of cash flows, and the sources of cash flows can reveal information to the analyst, including:

The sources of financing the company’s capital spending.

The company’s dependence on borrowing. The quality of earnings.

Page 20: Cash Flow Analysis

Ratio Analysis

This ratio gives the analyst information about the financial flexibility of the company and is particulary useful for capital- intensive firms and utilities

This ratio gives a measure of a company’s ability to meet maturing debt obligations.

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Patterns of cash flows Cash flow information may help analyst identify companies

that may encounter financial difficulties, they base their

analysis on: Healthy companies tend to have a relative stable relations

among the cash flows for three sources, correcting any given

year’s deviation from their norm within one year.

Unhealthy companies exhibit cash declining cash flow from

operations and financing and declining cash flows for

investment 1 or 2 year prior bankrupt.

Unhealthy companies tend to spend more cash flows to

financing sources than they bring during the year prior to

bankruptMichael T. Dugan and William D. Samson

Page 22: Cash Flow Analysis

Company performance

Cash flow and free cash flow, are often used

as metrics to gauge whether the financial

performance of a company is sustainable.

A company that is able to consistently

generate cash flow in excess of capital

expenditures is considered to have the

flexibility to expand as new investment

opportunities arise and/or to pay additional

dividend to shareholders

Page 23: Cash Flow Analysis

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