Net Cash Flows
Refers to the amount of cash available for distribution to both debt and
equity claims of a business or asset. This is calculated from the net cash generated
from operations and investment over time.
Net Cash Flows is preferred as basis of valuation if any of the following conditions are
present:
 Company does not pay dividends
 Company pays dividends but the amount paid out significantly differs from its
capacity to pay dividends
 Net Cash Flow and profits are aligned within a reasonable forecast period
 Investor has a control perspective. If an investor can exert control over a
company, dividends can be adjusted based on the decision of the controlling
investor.
 EBITDA and EBIT are both metrics that are before taxes ; cash flows that are available to
investors should be after satisfying tax requirements of the government.
 EBITDA and EBIT also do not consider differences in capital structures since it does not
capture interest payments, dividends for preference shares and funds sourced from
bondholders to fund additional investments.
 All these measures also do not consider reinvestment of cash flows made into the firm for
additional working capital and fixed assets investment that are necessary to maximize longterm stability of the business.
In valuation, analyst find analyzing cash flows and its sources helpful in understanding the
following:
 Source of financing for needed investments
 Reliance on debt financing
 Quality of earnings
The two levels of Net Cash Flow
1. Net Cash Flows to the Firm
2. Net Cash Flows to Equity
Net Cash Flow to the Firm
Refers to the cash flow available to the parties who supplied capital after paying all
operating expenses, including taxes, and investing in capital expenditures and working
capital as required by business needs.
Net Cash Flow to the firm can be computed or derived using the following approaches.
A.
Based from Net Income (or indirect approach)
Net Income Available to Common shareholders
Php xxx
Add: Non Cash Charges (net)
xxx
Add: Interest Expenses (net of Taxes)
xxx
Add/Less: Adjustment in Working Capital
xxx
Less: Net Investment in Fixed Capital
(Purchases – Sales of Fixed Capital Investment)
xxx
Net Cash Flows to the Firm
Php xxx
 Net Income Available To Common Shareholders
Basic measure of a firm’s profitability which refers to the bottom line figure in an income
statement.
 Non-Cash Charges (Net)
Pertains to non-cash items that are included in the computation of net income. Analyst usually
look at the statement of cash flow to validate potential non-cash charges.
 Depreciation and Amortization
When a firm acquires a fixed asset like equipment or intangible asset, the initial cash flow is
made at point of acquisition and is presented in the balance sheet.
 Restructuring changes
Restructuring refers to the change in the organizational structure or business model of a
company adapt to changing economic climate or business needs.
 Provision for Doubtful Accounts
These are estimated amount to be incurred for the customers inability to pay on time which is
cumulatively accounted under the statement of financial position reported against thw accounts
receivable.
 After-Tax Interest Expenses Interest expense (net of any tax savings)
This interest expense is a cash flow intended for the debt providers. In the
Philippines, interest expense is a tax-deductible expense for the company.
 Working Capital Adjustment
Also known as working capital, this item represents the net investment in
current assets such as receivables and inventory reduced by current liabilities like
payables.
 Investment in Fixed Capital
Pertains to cash outflows made to purchase or pay for capital expenditures
that are required to support existing and future operating needs.
B. From Statement of Cash Flows
Cash Flows from Operating Activities
Php xxx
Add: Interest Expense (net of Taxes)
xxx
Less: Cash Flows from Investing Activities
xxx
Net Cash Flows to the Firm
Php xxx
*only if deducted from the operations
 Cash flow from operating activities
This represents how much cash generated from its operations.
 Cash flow from investing activities
This represents how much cash is disbursed (received) for investments in (sale of) long-term
assets like property , plant and equipment and strategic investments in other companies.
 Cash flow from financing activities
This represents how much was raised (or repaid) to finance the company.
C. From Earnings Before Interest , Taxes , Depreciation and Amortization (EBITDA)
EBITDA , net of Taxes
Php xxx
Add: Tax Savings on Noncash Charges
xxx
Add/Less: Working Capital Adjustments
xxx
Less: Investment in Fixed Capital
xxx
Net Cash Flows to the Firm
Php xxx
EBITDA or Earnings Before Interest , Taxes , Depreciation and Amortization
pertains to income before deducting interest , taxes , depreciation and
amortization expenses, net of taxes.
Net Cash Flow to Equity
Refers to cash available for common equity participants or shareholders only after
paying operating expenses, satisfying operating and fixed capital requirements and settling cash
flow transactions involving debt providers and preferred shareholders.
Net Cash Flows to the Firm
Php xxx
Add: Proceeds from Borrowings
xxx
Less: Debt Service
xxx
Add: Proceeds from Preferred Shares Issuance
xxx
Less: Dividends on Preferred Shares
xxx
Net Cash Flows to the Equity
Php xxx
 Proceeds from Borrowing
This refers to the amount of cash received by the company as a result of borrowing of
long-term debt.
 Debt Service
Is the total amount used to service the loans or debt financing. This is the total
amount of loan repayment and the interest expenses, net of income tax benefit.
 Proceeds from Issuance of Preferred Shares
Same with the debt, preferred shares as another form of financing, other than the
issuance of ordinary equity, must also be factored in the calculation of the net cash flows
available to equity.
 Dividends on Preferred Shares
Since payments made to preferential shareholders in the form of dividends are
outflows. This must be incorporated in the calculation as a reduction of the net cash flows to
equity.
NCFE can be determined under the following approaches:
A. Based from Net income (or indirect approach)
Net Income Available to Common shareholders
Php xxx
Add: Non Cash Charges (net)
xxx
Add: Interest Expense (net of Taxes)
xxx
Add/Less: Adjustment in Working Capital
xxx
Less: Net Investment in Fixed Capital
(Purchase – Sales of Fixed Capital Investnent)
xxx
Net Cash Flows to the Firm
xxx
Add: Proceeds from Borrowing
xxx
Less: Debt Service
xxx
Add: Proceeds from Preferred Shares Issuance
xxx
Less: Dividends on Preferred Shares
xxx
Net Cash Flows to the Equity
Php xxx
B. From Statement of Cash Flows
Cash Flows from Operating Activities
Php xxx
Add: Interest Expense (net of Taxes)
xxx
Less: Cash Flows from Investing Activities
xxx
Net Cash Flows to the Firm
xxx
Add: Proceeds from Borrowing
xxx
Less: Debt Service
xxx
Add: Proceeds from Preferred Shares Issuance
xxx
Less: Dividends on Preferred Shares
xxx
Net Cash Flows to the Equity
Php xxx
C. From Earnings Before Interest, Taxes, Depreciation and
Amortization (EBITDA)
EBITDA, net of Taxes
Php xxx
Add: Tax Savings on Noncash Charges
xxx
Add/Less: Working Capital Adjustments
xxx
Less: Investment in Fixed Capital
xxx
Net Cash Flows to the Firm
xxx
Add: Proceeds from Borrowing
xxx
Less: Debt Service
xxx
Add: Proceeds from Preferred Shares Issuance
xxx
Less: Dividends on Preferred Shares
xxx
Net Cash Flows to the Equity
Php xxx
Terminal Value represents the value of the company in perpetuity or in
going concern environment.
Basis of Terminal Value
1.
Liquidation Value
2.
Estimated Perpetual Value
3.
Constant Growth
4.
Scientific Estimates