Practical financial manaegment lasher 7th ed chapter 03

Chapter 3 - Cash Flows And Financial Analysis


Users of Financial Information
Investors
– Make judgments about the firm's securities
– Financial Analysts report to investment community

Vendors
– Sell to the firm on credit

Management
– Highlight areas in which attention will improve performance

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Sources of Financial Information
Annual Report
– Management's report card to
stockholders on own
performance
– The primary source of financial
information
– Required of publicly traded
companies

Other Sources
– Reports from
brokerage firms
and advisory

services
– Value Line
– Credit reports

– Must be audited
– GAAP

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Orientation of Financial Analysts

Critical and investigative
Looking for current or potential problems
Looking for the physical reasons behind
financial results

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Statement of Cash Flows
Businesses run on cash, not accounting
profits
It is possible for a business to go out of
business while making a profit
Statement of Cash Flows
– Reports inflows and outflows of money
– Developed from the income statement and
balance sheet

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Building the Statement of Cash
Flows – Basic Approach
Build a Statement of Cash Flows from two balance
sheets and an income statement
Analyze where money has come from and gone to
Begin with some personal examples

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Table 3-1 Cash Flow Rules

Asset Increase = Use
Liability Increase = Source
Asset Decrease = Source
Liability Decrease = Use

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Buying a Car on Credit
Joe Jones and His New Car

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Buying and Selling Cars Sally Smith and Her Two Cars

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Buying and Selling Cars Sally Smith and Her Two Cars

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Business Cash Flows
Three sources of cash flows:
Operating Activities – day-to-day activities
Investing Activities – firm buys or sells ( or invests in) fixed
assets that enable it to do business.

Financing Activities – borrow money, pay off loans, sell
stock, pay dividends.

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Figure 3.2 BUSINESS CASH FLOWS

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Example 3-1 Business Cash Flows

Additional Information

Belfry also sold new stock during
the year receiving a total of $800
and paid its shareholders dividends
of $500.


Operating Activities
Net Income$ 1,000
Depreciation

500

Net Change in Current Accts

(600)

Cash from Operating Activities

$

900

Detail of Changes in Current Accounts
Account

Begin

Receivables
Inventory

EndSource/(Use)
$3,000

2,000

$2,900

3,200

$ 100
(1,200)

Payables

1,500

2,100

600

Accruals

500

400

(100)

$ (600)


Investing Activities

Purchase of Fixed Assets $(2,000)
Use Change in Gross Fixed Asset
Account


Financing Activities
Increase in Long Term Debt
Sale of Stock
Dividends Paid

$ 1,200

800
(500)

Cash from Financing Activities

$ 1,500



Free Cash Flows (FCF)
Used to estimate whether a company
will provide or require cash in future

Cash generated by operations that’s
available for distribution to investors.
If negative, owners must borrow or sell
equity just to keep going as before

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Calculating Free Cash Flow
NOPAT is net operating profit.
T = tax rate
NOPAT = EBIT – (T)(EBIT) = EBIT (1 – T)

Note: If there is no debt, NOPAT equals net income

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Calculating Free Cash Flow
Depreciation is subtracted from revenue when
calculating EBIT.
Depreciation is a noncash charge, so EBIT
understates cash flow by at least that amount.
Adding back depreciation gives a figure that’s
closer to cash flow called operating cash flow.

Operating Cash Flow = NOPAT + Depreciation

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Calculating Free Cash Flow
Money available to investors can be written
as:
FCF = Operating Cash Flow
– Increase in Gross Fixed Assets
– Increase in Current Accounts

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Calculating Free Cash Flow to Equity (FCFE)
If a company is able to distribute cash to
stockholders, then the equation becomes:
FCFE = Operating Cash Flow
– Increase in Gross Fixed Assets
– Increase in Current Accounts
– (1-T)Interest – Principal Reduction

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