Cash Flow Analysis
Lindsay Dastrup
Overview
•
•
•
•
•
Direct method
Indirect method
Cash flow patterns
Cash flow ratios
Free cash flow
Categories of Cash Flow
• Operating Activities
–
transactions that affect the determination of net income
• Investing Activities
–
sale and purchase of property, buildings, and equipment
• Financing Activities
–
transactions whereby cash is obtained from or repaid to owners
Cash Flow from Operations
TWO METHODS
• Direct method
– the reporting of the cash
received or disbursed of
each income statement
item
• Indirect method
– the adjustment of the net
income for items that do not
affect cash flow
Orchard Blossom Company
End of the
Year
Balance Sheet
Cash
Accounts receivable
Inventory
Wages payble
Income Statement
Sales
Cost of goods sold
Wages expenses
Depreciation expense
Net income
$25
60
75
10
150
-80
-25
-30
15
Beginning of
year
15
40
100
7
Direct Method
Sales and cash collected from customers
Beginning accounts receivables
+sales
=cash available for collection
-ending accounts receivable
=cash collected from customers
$ 40
150
$ 190
60
$ 130
Direct Method
Cost of goods sold and cash paid for inventory
Ending inventory
+cost of goods sold
=required inventory
-beginning inventory
=inventory purchased
$ 75
80
$ 155
100
$ 55
Direct Method
Wages expense and cash paid for wages
Beginning wages payable
+wage expense
=total wages payable
-ending wages payable
=cash paid for wages
$ 7
25
$ 32
10
$ 22
Cash from Operating Activities:
Direct Method
Cash collected from customers
Cash paid for inventory
Cash paid for wages
Cash paid for depreciation
Net cash from operating activities
$ 130
-55
-22
0
$ 53
Indirect method
Net income
+depreciation
-increase in accounts receivables
+decrease in inventory
+increase in wages payable
= net cash from operating activities
$ 15
30
-20
25
3
$ 53
Cash from Investing
Long-term investments
Book value of long term investments sold
+gain (loss) on sale
=cash proceeds
Cash from Investing
Buildings and Equipment
Beginning buildings and equipment balance
-original cost of buildings and equipment sold
=ending balance
Cash from Financing
Dividends paid
Beginning balance of retained earnings
-dividends declared
+net income
=ending balance of retained earnings
Cash from Financing
Dividends paid
Dividends declared
-increase in dividends payable
=cash paid for dividends
Cash from Financing
Issued common stock
+borrowed short term debt
+borrowed long term debt
-dividends paid
-treasury stock purchases
=cash from financing activities
Analysis of Cash flows
• Cash flow patterns
• Cash flow ratios
Cash Flow Patterns
Start-up, high growth company
Large cash inflows from financing pays for
• capital expansion
• subsidized negative cash flow from operations
Cash flow patterns
Steady-state company
Cash flow from operation is sufficient to
• replenish long term assets
• pay dividends
Cash flow pattern
Cash cow
Large cash inflow from operations
• capital expansion
• repay loans
• pay cash dividends
• repurchase of company stock
Cash flow ratios
Cash flow–to-net income
Cash from operations
Net income
• Measure of earnings quality
• Tends to be greater than 1
• Should remain fairly stable for the years for a specific
company
Cash flow ratios
Cash flow adequacy
Cash from operations
Cash required for investing activities
• Measures relationship between investment spending and
cash generated by operations
• Indicate a company’s attitude towards reinvestment in
long-lived production assets
• When ratio is small it indicates that cash flows from
operations fall short of funding growth
Cash flow ratios
Cash times interest earned
(Cash from operations + Interest paid + Taxes paid)
Interest expense
• Measures ability to service debt
• Generally, a higher ratio indicates more solvency
Free cash flow
Profit after tax
+depreciation
+investment in fixed assets
+investment in working capital
=free cash flow
Tire City Corporation
1. Given the income statement and balance sheet,
determine the operating cash flows, the investment cash
flows, and the financing cash flows
2. Determine the value of the firm using the following
assumptions:
WACC (discount rate)= 15.06%
Growth rate= 5.0%
1998 FCF= $759.24
Tire City Corporation
For years ending 12/31
1993
1994
1995
1996
1997
INCOME STATEMENT
Net Sales
Cost of sales
Gross profit
16,230.00
9,430.00
6,800.00
20,355.00
11,898.00
8,457.00
23,505.00
13,612.00
9,893.00
28,206.00
16,334.40
11,871.60
33,847.20
19,601.28
14,245.92
Net income
5,195.00
160.00
1,445.00
119.00
1,326.00
546.00
780.00
6,352.00
180.00
1,925.00
106.00
1,819.00
822.00
997.00
7,471.00
213.00
2,209.00
94.00
2,115.00
925.00
1,190.00
8,965.20
313.00
2,593.40
87.50
2,505.90
1,002.36
1,503.54
10,758.24
313.00
3,174.68
104.72
3,069.96
1,227.99
1,841.98
155.00
200.00
240.00
300.71
368.40
Selling, general, and
administrative expenses
Depreciation
EBIT
Net interest expense
Pre-tax income (EBT)
Income taxes
Dividends
Tire City Corporation
BALANCE SHEET
Assets
Cash
Accounts receivable
Inventories
Total current assets
508.00
2,545.00
1,630.00
4,683.00
609.00
3,095.00
1,838.00
5,542.00
706.00
3,652.00
2,190.00
6,548.00
847.20
4,382.40
1,625.00
6,854.60
1,016.64
5,258.88
3,153.60
9,429.12
Net plant & equipment
3,232.00
1,335.00
1,897.00
563.00
3,795.00
1,515.00
2,280.00
368.00
4,163.00
1,728.00
2,435.00
2,000.00
6,163.00
2,041.00
4,122.00
400.00
6,563.00
2,354.00
4,209.00
Total assets
6,580.00
7,822.00
8,983.00
10,976.60
13,638.12
Total current liabilities
125.00
1,042.00
1,145.00
2,312.00
125.00
1,325.00
1,432.00
2,882.00
125.00
1,440.00
1,653.00
3,218.00
125.00
297.17
1,728.00
1,983.60
4,133.77
125.00
867.79
2,073.60
2,380.32
5,446.71
Long-term debt
1,000.00
875.00
750.00
625.00
500.00
Common stock
Accumulated retained earnings
Total shareholders' equity
1,135.00
2,133.00
3,268.00
1,135.00
2,930.00
4,065.00
1,135.00
3,880.00
5,015.00
1,135.00
5,082.83
6,217.83
1,135.00
6,556.41
7,691.41
Total liabilities and equity
6,580.00
7,822.00
8,983.00
10,976.60
13,638.12
CapEx
Gross plant & equipment
Accumulated depreciation
Liabilities
Current Debt
Bank debt
Accounts payable
Accrued expenses
Tire City Corporation
1993
Operating Cash flows
ONWC
Change in ONWC
CAPEX
UFCF
2,496.00
1994
1,335.00
2,785.00
289.00
563.00
483.00
1995
1,538.40
3,455.00
670.00
368.00
500.40
1996
1,869.04
3,143.00
(312.00)
2,000.00
181.04
1997
2,217.81
4,975.20
1,832.20
400.00
(14.39)
Tire City Corporation
Year
UFCF
Discounted CF years 1-2
SUM years 1-2)
1995
0
146.47
Terminal Cash Flow
Discounted terminal value
7,547.14
5,700.77
Firm Value
5,847.25
1996
1
181.04
1997
2
(14.39)
157.34
(10.87)
1998
3
759.2424
Summary
• Operating
– Income statement and current assets and liabilities
• Investing
– Long-term assets
• Financing
– Long-term liabilities and owner’s equity
Summary
• Ratios
– Cash flow to net income
– Cash flow adequacy
– Cash times interest earned
Reading List
• Intermediate Accounting by Stice, Stice, Skousen; 15th
edition
• Principles of Corporate Finance by Brealey, Myers, Allen;
8th edition