cash flow analysis-ppt

8/3/2019 Cash Flow Analysis-PPT

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Cash Flow Analysis

K.VISWANATHAN

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What is Cash flow and its analysis

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Cash flow is essentially the movement of money into and out of

any business; it's the cycle of cash inflows and cash outflows that

determine the business' solvency.

Cash flow analysis is the study of the cycle of the business' cash

inflows and outflows, with the purpose of maintaining an

adequate cash flow for the business, and to provide the basis for

cash flow management.Cash flow analysis involves examining the components of the

business that affect cash flow, such as accounts receivable,

inventory, accounts payable, and credit terms. By performing a

cash flow analysis on these separate components, we can moreeasily identify cash flow problems and find ways to improve the

cash flow of the business


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The How and why of Cash Flow analysis

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A quick and easy way to perform a cash flow

analysis is to compare the total unpaidpurchases to the total sales due at the end of

each month.

If the total unpaid purchases are greater thanthe total sales due, we need to spend more

cash than we receive in the next month,

indicating a potential cash flow problem.

A cash flow analysis of the accounts receivable

shows which customers are slow payers.


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Steps involved in Cash Flow Analysis

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This type of cash flow analysis is called cash budgeting

analysis. It is part of a firm's financial forecasting plan.Step 1: Cash inflow:

Determine the amount of cash that will flow into the

firm during the month.

If it is a starting business, we need to include thebeginning balance in cash that should be available

every month. There would also be the amount of sales

made/ to be made during the first month.

Sales would include both cash sales and sales that to

the customers who pay on credit.


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Deciding acceptable end balance

We expect the cash flow into the firm (Step 1) to be

greater than the cash that will flow out of the firm

(Step 2). Then we will have sufficient cash to operate

the firm. This can be calculated using a work sheet.

The ending balance for the first month becomes thebeginning balance for the second month. We may do

the same type of analysis. Each month, we may have to

add more items to the cash flow analysis as the

business grows.We need to decide what the minimum acceptable

ending cash balance for the firm and aim towards that

figure each month.


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What to do, if cash flow turns negative?

If the cash flow turns negative for any one month, we

may have to borrow money for that month from family

or friends, investors, or from a bank or other financial

institutions.

Then, when the cash flow turns positive the nextmonth, we can repay that loan.

We need to keep on doing this each month for the

entire forecasting period. We need to keep the

borrowing to a minimum and keep cash inflow greaterthan the outflows.

Cash budget is a financial forecasting document, so

we should follow it as closely as possible.


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Types of Cash Flows

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The (total) net cash flow of a company over a period

(typically a quarter or a full year) is equal to the change

in cash balance over this period:

-positive if the cash balance increases (more cash

becomes available),

-negative if the cash balance decreases.The total net cash flow is the sum of cash flows that are

classified in three areas: Operating, Financing and

Investing cash flows

1. Operating Cash Flows : Cash received or expendedas a result of the company's internal business activities.

It includes cash earnings plus changes to working

capital. Over the medium term, this must be net

positive if the company is to remain solvent.


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Types of Cash Flows

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2. Investment cash flows: Cash received from the sale

of long-life assets, or spent on capital expenditure

(investments, acquisitions and long-life assets).

3. Financing Cash Flows: Cash received from the issue

of debt and equity, or paid out as dividends, share

repurchases or debt repayments.Let us see how we can calculate them.


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Operating Cash flows

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Equation to calculate Operating cash flow :

EBIT (earnings before interest and taxes)+ Depreciation-

Taxes.

EBIT is also known as operating income.

This information can be found in a company's annual

report Operating cash flow is a solid measure of a

company's profits because it refers to actual cash made

from operations and is thus hard to manipulate.

Operating cash flow is important since a companycould be bringing in tons of money but still be

struggling to pay its bills.


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Looking at operating cash flow will show us whether

a company is burning more money than it is earning.

Operating cash flow is a good at-a-glance snapshot

of how the business is doing. Positive cash flow is a

good sign, while negative cash flow needs to have a

one-time explanation (an investment or expense thatwill not be repeated; for example, an acquisition or a

new factory).

If a company's cash flow has been negative for years,

or if its cash flow is steadily decreasing, this is awarning sign that means we need to dig deeper before

making any type of investment in the company.


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In recent years, cash flow has gained in popularity as a

financial measure because it is more difficult to

manipulate than certain other metrics, such as revenues.

A company could make its revenues look bigger by, for

example, postponing rebates (which would lower

revenues) until the next reporting period, thus creating

the appearance of a business that's more prosperous

than it really is.

However, because operating cash flow deals with

actual money, it's much harder for a company to

"massage the numbers" into saying what management

wants them to say.

That is why it is such a key financial metric, despite its

seeming simplicity.


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Operating Cash flow- Example

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OCF= Net Income + Depreciation - Amount by which Net

Working Capital Changes (latter in symbols: NWC)

= 487 + 65 - NWCNWC changes EXCLUDING

Cash

= 552 - NWC Marketable Securities

Current Portion (CurrentMaturities) of Long Term Debt

We can remember a simple formula to link the three major

working capital accounts to change in net working capital:

NWC = AR(Accounts Receivable) + I (Inventory) - AP

(Accounts Payable

= (600-400) + (350-250) - (250-175)

= (200) + (100) - (75)

= 300 - 75

= 225


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Investing Cash flows

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What is an investing cash flow?

An item on the cash flow statement that reports the aggregate

change in a company's cash position resulting from any gains (orlosses) from investments in the financial markets and operating

subsidiaries, and changes resulting from amounts spent on

investments in capital assets such as plant and equipment.

When analyzing a company's cash flow statement, it isimportant to consider each of the various sections which

contribute to the overall change in cash position.

In many cases, a firm may have negative overall cash flow for a

given quarter, but if the company can generate positive cash flow

from its business operations, the negative overall cash flow may

be a result of heavy investment expenditures, which is not bad .


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Using cash flow for investment decisions

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An example:

A firm is deciding on investing in an energyefficiency system. Two possible systems are

under investigation

One yields quicker results in terms ofenergy savings than the other, but the

second may be more efficient later

Which should the firm invest in?


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Discounted Cash Flow System A


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Discounted Cash Flow System B


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System A represents the better

investment

System B yields the same return after six

years but the returns of System A occur

faster and are worth more to the firm than

returns occurring in future years even

though those returns are greater


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Financing Cash flows

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Those activities that result in changes in size and composition

of owners capital and borrowing of the organization.

It includes receipts from issuing shares, debentures, bonds,borrowing and payment of borrowed amount, loan etc.

Sale of share

Buy back of shares

Redemption of preference shares

Issue / redemption of debentures

Long term loan / payment thereof

Dividend / interest paid


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Financing Cash flows

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The formula for cash flow from financing activities is

as follows:

Cash Received from Issuing Stock or Debt - Cash Paidas Dividends and for Re-Acquisition of Debt/Stock

Negative numbers can mean the company isservicing debt

But it can also mean the company is makingdividend payments and stock repurchases, whichinvestors might be glad to see.


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Cash Flows and life cycle state of a company

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Under Discounted Cash Flow Method, we come acrosstwo major states of the company in its life cycle :1. The first one is the period when the company is in

its active growth phase. In this phase, normally thecompany will have to be extremely careful andcalculative about the management of all its cashflows.

2. The second state represents the period when thecompany is supposed to have attained steadiness

and the further growth of the company is more orless steady. By now, the companys system ofmanaging the cash flows should have becomesteady.


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During the first state- i.e the growth phase, thecash flows have to be monitored carefully. The

following should be ensured:1. Enough cash flows should be available to continue

with the process of operations- payment for rawmaterials / inventory , salary to workers, paymentof interest on borrowings etc. The inflows fromsales / services provided should be meticulouslymonitored to receive them in a timely manner.

2. All investments to be carefully considered, beforemaking them. Each investment should be appraised

to ensure that the ROI is greater than cost of funds3. There will be more financial cash inflows thanoutflows during this period.


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During the second state- i.e the consolidated phase,the cash flows have to be continued as predicted.

1. Continuance of operations has to be ensured. Enoughcash flows to be available to continue with the processof operations. Adequate systems to be in place by thistime to ensure meticulous monitoring of the inflowsand out flows in a timely manner.

2. More investments could be needed to replace existingfixed assets. There could also be adequate cash flowsfrom the sale of old investments. All new investmentsto be carefully considered, before making them-toensure that the ROI is greater than cost of funds.

3. The Company also could go for repayment of its debtand increase of equity. Non cash flows like bonusshares may be there. The company may also go forconsolidation of its control by purchase of its ownshares.


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Cash Flows and Financial flexibility

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Management of cash flows is nothing butmaintenance of the financial flexibility ofthe company.

The cash flows-both inward and outward-

should be adequate and timely. There is nopoint in keeping the company rich, if it isunable to meet, for example, its day to dayoperational commitments.


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Cash Flows and Dividend Policy

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Cash flows happen mainly from revenue / sales.

Cash flows are also impacted by the Dividend policyof the company, which determines the amount ofearnings to be retained in the company for its futuregrowth and the amount to be distributed by way ofdividend.

The company cannot follow the policy ofdistribution of all its net earnings as dividend. It alsocannot follow the policy of retaining all its netearnings. So a prudent policy in terms of the

industry, in which the company operates as well asthe financial strength of the company needs to befollowed.


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Some suggestions to improve Cash Flows and

Financial flexibility

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We should take a look at a 2 months cash budgetgoing forward.

We should take a look on a week-by-week basis,roughly a month to a quarter out in the future, andput down what we expect to receive and whatpayments we actually expect to make.

Though it sounds simple, a lot of companies dontdo that.

If we look at the historical business from last month

or last year, thats an indicator of the ability of thecompany to be profitable. Hence when we are ableto match the cash in and cash out, it can beenlightening.

i i h l d


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We should be more aware of the sources and uses

of cash in the balance sheet and working capitalaccounts. Three primary issues to be considered here:1. Appropriately managing the accounts receivable,

which includes preparing bills faster for customers.

When economic times are better, some companiesmay go a week or two at a time without preparingand sending bills because the cash flow is not quiteas important. But now a days it is becoming moreimportant to prepare and collect the cash faster

2. The second component is inventory. Having a lot ofcash tied up in the inventory can be a constraint onthe company. We need to limit the amount of timethat cash is tied up in inventory. (Economic Order

Quantity)


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3. The third item is accounts payable and how slowlyor quickly the company pays its vendors. If thecompany has the ability to wait a little bit longerwithout impairing its credit standing with them, thatcan ultimately be a source of cash.

Another way is to have a close look at the items,considered under cash flow. Some of the traditionalcompanies will look at their net income, add backnon-cash items like depreciation and include themin their cash flow. But we need to be more realisticin doing it and do it only when warranted.


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How can the companys budget be made flexible forany unexpected receipts of expenditures?

The idea is to keep it on a rolling basis. The better way

is to look at it weekly, so that the company can better

account for the things, not originally planned. Suppose they need to pay for something else, they

can look out over four to six weeks ahead and find if

some vendor credit terms can allow them to delay the

payment of an item for a week. This way they can

manage their short-term future much better. Constantly

updating it allows the firm to be flexible.


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Why should you improve your cash flow?

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Ultimately, its not a lack of profitability that

causes problems for a company but a lack of

liquidity.

People talk about the five Cs of credit(character,

capacity, capital, collateral and conditions), but the most

important C is cash-i.e .Capital.

Liquidity is either cash or the companys abilityto turn their assets into cash quickly. Without

this, the company can have a hard time making

its payroll, paying its bills, etc.


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Benefits of improving your cash flow

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On improving cash flow, the first thing the

company achieves is financial flexibility.When the company is as efficient as it can be,

that gives them the ability to reduce leverage and

not carry a big debt load.It allows them to be in a better position during

a period of time when revenue drops or general

economic conditions are tough.

Thus financial flexibility buys the company the

required time during those tough circumstances

to tide over the hardships.


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THANK YOU

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Cash Flow Analysis

cash flow analysis-ppt

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