Evaluating Cash Flow

1

Key questions for cash flow statement analysis

How did this year’s cash flow impact the company’s:Credit profile?Liquidity?Growth opportunities?Shareholder distributions?Valuation model?

2

Cash Flow From Operations Section

Net incomeStrength of sales growth and profit margins on

income statementAbility to comfortably fund dividends from net

income Compare dividend payout ratio with industry

Dividends ÷ Net Income

3

Cash Flow From Operations Section

Net Working capitalConsuming significant cash beyond the level

suggested by sales growth? Compare Net Working Capital growth to Sales growth

(trend in NWC) NWC turnover: Sales-to-NWC (level of NWC)

Does CFFO include unsustainable working capital contraction, either from short-term asset contraction or liability growth?Check Current Ratio

4

Cash Flow From Operations Section

Overall CFFO resultCFFO-to-CapitalCFFO-to-SalesGrowth in CFFO

5

Investing activities Growth in Net PP&E

Capital Expenditures less Depreciation Evaluate level and trend of Property Plant &

Equipment turnover Sales-to-PP&E

Investing activities are volatile need to average and consider maintenance

requirements in worst case Are unsustainable asset sales being used to

generate cash? Capex vs Depreciation

6

Financing activities:Creditor Perspective

If company is a net borrower of funds Treating debt as the residual cash flow What are the uses of proceeds for additional debt?

NWC growth? PP&E growth? Dividends or stock buybacks? Cover operating losses?

Compare Debt growth with growth in: Sales and profits CFFO Assets (collateral)

Resulting impact on credit ratios

Assets

Equity

7

Financing activities:Creditor Perspective

Does the company have significant additional debt capacity? Credit ratios Has stock issuance been necessary to fund cash flow shortfalls

and build Equity, suggesting a lack of access to debt markets and excessive leverage?

Is short-term debt growth commensurate with short-term asset acquisition (or are short-term sources funding long-term needs)? Liquidity ratios level and trend

8

Financing activities:Stockholder Perspective

Are we using debt effectively to support growth? Too much debt can lead to

Missing future investment opportunities due to cash flow being directed to debt

Too little debt can unnecessarily Dilute returns to stockholders Limit cash distributions to stockholders Constrain growth today

Did cash flow available to stockholders grow sufficiently? Impact on stock price this year

9

Discretionary Cash Is it used to:

Increase dividends?Repurchase stock?Make growth investments?Reduce debt?Build cash on balance sheet?

10