CASH FLOWS ANALYSIS

It is the statement that tells about the inflows and outflows of the firm coming from:

- Operating activities- Financing activities- Investing activities

CASH FLOWS STATETEMENT

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THE CASH FLOWS AND THE FIRM’S BUSINESS CYCLE

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It is the cash flow generated by the firm from its day to day operations and not from financing or investment operations

Normal business activity of the company

Operating Cash Flow= EBITDA – change in working capital

CASH FLOWS FROM OPERATING ACTIVITIES

EBITDA

Change in WCChange in WC

Cash flow from operations

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EXAMPLE: CASH FLOWS FROM OPERATING ACTIVITIES

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Excess of cash that allows the firm to pay its debt, pay dividends, and make investment

Growth in cash flows from Operations depends on three variables:

- Business growth- Profitability growth- Working capital growth

Cash flows of companies having high working capital might decrease in periods of sales growth. Saying that the business does not throw off cash is a wrong conclusion!

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ANALYSIS OF CASH FLOWS FROM OPERATING ACTIVITIES

Cash flows coming from:

- Acquisitions and disposals

- R&D

-Investment in securities

- …

CASH FLOW FROM INVESTING ACTIVITIES

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Assess the investment policy of the firm:

- Define the development strategy of the firm:

• Organic growth (investment in PP&E);

• External growth (acquisitions)

-Analysis of the cash flows from disposals (sale of business units or other assets):

• Pay long term debt• Keep the core business

ANALYSIS OF CASH FLOW FROM INVESTING ACTIVITIES

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EXAMPLE

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Cash flows = Fund raising :

-Bank loans

- Issue of stock (capital increase)

- Issue of debt

CASH FLOW FROM FINANCING ACTIVITIES

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Cash flow from financing: result from the firm’s operations and its investment policy

Use external ressources if the capacity of the firm to generate internally cash is not adequate

Analyze the following:

- Is the cash flow from operations adequate to pay Medium and long term debt?

- To what extent the firm financed its investment from internal resources?

- Can the firm raise capital and how its shareholding structure is?

ANALYSIS OF CASH FLOWS FROM FINANCING ACTIVITIES

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EXAMPLE

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How strong is the firm's internal cash flow generation?

-Is the cash flow from operating activities positive or negative?

-If it is negative, why?

o Is it because its operations are unprofitable?

o Or is it having difficulty managing its working capital properly?

ANALYSIS OF CASH FLOWS: MAIN QUESTIONS

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Does the company have the ability to meet its short-term financial obligations, such as interest payments, from its operating cash flow?

How much cash did the company invest in growth?

- Are these investments consistent with its business strategy?

- Did the company use internal cash flow to finance growth, or did it rely on external financing?

ANALYSIS OF CASH FLOWS: MAIN QUESTIONS

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Did the company pay dividends from internal free cash flow, or did it have to rely on external financing?

What type of external financing does the company rely on?

- Equity, short-term debt, or long-term debt?-Is the financing consistent with the company's overall business risk?

ANALYSIS OF CASH FLOWS: MAIN QUESTIONS

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The Quality of Income Ratio is calculated as:

Cash Flow from Operations

Net Income

This ratio should be > 1 for a healthy firm

QUALITY OF INCOME RATIO

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PROBLEM SOLVING

1 2 3 4 5

Net PP&E 100 110 120 130 140

Working capital 200 225 250 280 315

EBITDA NA 40 44 48 52

Depreciation NA 10 11 12 13

Interest expense NA 15 17 19 22

Tax expense NA 7.5 8 8 8.5

Dividends

Source: Vernimmen

5 5 5 5

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1-Prepare a cash flow statement starting from year 22- Calculate the quality of income ratio of the firm 3- Analyze the growth in cash flows for the firm

A start up showed the floowing cash flows during the last 5 years of its business activity:

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