BUA321 Chapter 4 Notes
Chapter 4 Cash Flows and Planning
I.
Firm Cash Flow
A.
Cash flow (as opposed to accounting “profits”) is the primary
ingredient in any financial valuation model.
B.
From an accounting perspective, cash flow is summarized in a firm’s
statement of cash flows.
C.
Firms often focus on
1.
operating cash flow, which is used in managerial decisionmaking
2.
free cash flow, which is closely monitored by participants in
the capital market.
D.
Depreciation is the portion of the costs of fixed assets charged
against annual revenues over time.
1.
Amortization – write-off of intangible assets
2.
Depletion – write-off natural resources
E.
Depreciation for tax purposes is determined by using the modified
accelerated cost recovery system (MACRS).
F.
Financial managers are much more concerned with cash flows rather
than profits.
1.
To adjust the income statement to show cash flows from
operations, all non-cash charges should be added back to net profit
after taxes.
2.
non-cash expenses create a tax shield and enhance cash flow.
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BUA321 Chapter 4 Notes
G.
Property Classes under MACRS
H.
Rounded Depreciation Percentages by Recovery Year Using MACRS
for First Four Property Classes
Content Coordinator: Dr. Lawrence Byerly
BUA321 Chapter 4 Notes
II.
Depreciation calculation
Depreciable Basis  Asset Cost  Installati on Cost
Depreciation Expense  Basis * %
Book Value  Deprec. Basis - Accum. Depr
Basis = 90000 5 yr asset
yr
%
Depr
1
.20
1800
Ac
Depr
1800
2
.32
2880
4680
42000
3
.19
1710
6390
2610
4
.12
1080
7470
1530
5
.12
1080
8550
4500
6
.05
9000
0
4500
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BV
72000
BUA321 Chapter 4 Notes
Content Coordinator: Dr. Lawrence Byerly
BUA321 Chapter 4 Notes
III.
Interpreting Statement of Cash Flows
A.
The statement of cash flows ties the balance sheet at the beginning
of the period with the balance sheet at the end of the period after
considering the performance of the firm during the period through the
income statement.
B.
The net increase (or decrease) in cash and marketable securities
should be equivalent to the difference between the cash and marketable
securities on the balance sheet at the beginning of the year and the end of
the year.
IV.
Operating Cash Flow
A.
A firm’s operating Cash Flow (OCF) is the cash flow
a firm generates from normal operations—from the production and sale of
its goods and services.
V.
Free Cash Flow
A.
Free cash flow (FCF) is the amount of cash flow available to
investors (creditors and owners) after the firm has met all operating needs
and paid for investments in net fixed assets (NFAI) and net current assets
(NCAI).
http://www.youtube.com/watch?feature=player_detailpage&v=6TwWcykX9J4
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BUA321 Chapter 4 Notes
VI . Financial Planning Process
B.
The financial planning process begins with long-term, or strategic,
financial plans that in turn guide the formulation of short-term, or
operating, plans and budgets.
C.
Two key aspects of financial planning are cash planning and profit
planning.
D.
Cash planning involves the preparation of the firm’s cash budget.
E.
Profit planning involves preparation of pro forma statements.
FCF  OCF  NFAI  NCAI
 $350  $300  $0  50
OCF  EBIT  Taxes  Depreciation
 $370  $120  $100  $350
NCAI  CA  A / P and Accruals
 [($2,000 - $1,900) - ($800 - $700)]  $0
NFAI  Net Fixed Assets  Depreciation
 [($1,200 - $1,000)  $100  $300
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BUA321 Chapter 4 Notes
Net Income
Non-Cash Expenses
Taxes ($)
EBIT
Change in CA (if given)
CA (beg)
CA (end)
Change in CL (if given)
A/P and Accruals (beg)
A/P and Accruals (end)
Change in FA (if given)
Fixed Assets (beg)
Fixed Assets (end)
OCF (if given)
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BUA321 Chapter 4 Notes
VI.
Long-Term (Strategic) Financial Plans
A.
Long-term (strategic) financial plans lay out a company’s planned
financial actions and the anticipated impact of those actions over periods
ranging from 2 to 10 years.
B.
Firms that are subject to high degrees of operating uncertainty,
relatively short production cycles, or both, tend to use shorter planning
horizons.
C.
These plans are one component of a company’s integrated strategic
plan (along with production and marketing plans) that guide a company
toward achievement of its goals.
VII.
Short-Term (Operating) Financial Plans
A.
Short-term (operating) financial plans specify short-term financial
actions and the anticipated impact of those actions.
B.
Key inputs include the sales forecast and other operating and
financial data.
C.
Key outputs include operating budgets, the cash budget, and pro
forma financial statements.
VIII.
Financial planning Process
A.
involves guiding, coordinating, and controlling the firm’s actions to
achieve its objectives.
B.
Two key aspects of financial planning are cash planning and profit
planning.
C.
Cash planning involves the preparation of the firm’s cash budget.
IX.
Profit planning involves the preparation of both cash budgets and pro
forma financial statements.
A.
Pro forma financial statements are projected, or forecast, financial
statements – income statements and balance sheets.
1.
A simple method for developing a pro forma income statement
is the “percent-of-sales” method.
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BUA321 Chapter 4 Notes
B.
Probably the best approach to use in developing the pro forma
balance sheet is the judgmental approach.
1.
The accounting balance sheet is created using the debit-credit
system
2.
This balance sheet will not balance
C.
One of the outcomes is the external funding required to finance
asset growth
1.
A deficit requires external funds to be gathered
2.
A surplus requires temporary investment or a payback
D.
However pro forma statements are prepared, analysts must
understand how to use them to make financial decisions.
1.
Financial managers and lenders can use pro forma statements
to analyze the firm’s inflows and outflows of cash, as well as its
liquidity, activity, debt, profitability, and market value.
2.
Various ratios can be calculated from the pro forma income
statement and balance sheet to evaluate performance.
3.
Cash inflows and outflows can be evaluated by preparing a
pro forma statement of cash flows.
4.
After analyzing the pro forma statements, the financial
manager can take steps to adjust planned operations to achieve
short-term financial goals.
Content Coordinator: Dr. Lawrence Byerly
BUA321 Chapter 4 Notes
Chapter 4 Web exercise (50 points)
In Yahoo finance
Go to Competitors (10)
Who are the company’s primary competitors (name and ticker)?
1)
2)
3)
How does your company compare to the revenues, gross margin, PE
and EPS of the competitors and the industry?
Go to Analyst opinion (3)
How do the analyst’s feel about this company?
Go to Analyst Estimates (10)
What are the next year’s estimates for
Revenue
EPS
PE (under growth estimates) How does the company stack up
against the industry and the sector? What does this relationship
show?
Go to Basic chart (this chart shows how your company’s prices have moved
historically. You can also compare it to an index and another company
Click the S&P index box and type in the ticker symbol for one of your company’s
competitors above. Choose the big chart and the 1 year chart.
Content Coordinator: Dr. Lawrence Byerly
BUA321 Chapter 4 Notes
Copy and paste chart into this word document. (5)
How has your company’s prices moved relative to the index and the competitor? (5)
Now go back and switch the chart to the 5yr chart.
Now compare to the index and competitor. (5)
Calculate the CFAT OCF and FCF for the company in your web exercise for the last 2
years. (use Free Cash Flow Calculation) Get the data from the annual financial statements you
downloaded. Find the financial statements at yahoo finance under the statement links for
your company.
Copy and paste special the worksheet below your explanation. Type in the answers. (10)
OCF
FCF
Past year
Most recent year
Explain the differences between the numbers if any. (5)
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CFAT
BUA321 Chapter 4 Notes
Use the textbook problems at the end of the chapter for this assignment. (15 points)
P4-2. LG1 (4) (CB Cash Flows)
P4-3.
LG 1, 2: MACRS depreciation expense, taxes, and cash flow (5)
a. (1)
(CB Cashflows)
Depreciation expense 
(MACRS depreciation percentages found on Table 3.2 in the text.)
b. (4) New taxable income 
Tax liability 
Original tax liability before depreciation expense:
Tax liability 
Tax savings 
P4-6.
LG 2: Finding operating and free cash flows (6)
(free cash flow calculation)
(2 each)
b.
OCF  EBIT  taxes  depreciation
OCF 
c.
FCF  OCF  net fixed asset investment*  net current asset investment**
FCF 
d.
Explain the differences between the answers in b and c.
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