Module 11

Cash Flows and Decisions Revisited – Modules 2 & 3 +

Instructor: David Sumpton

Contact: dsumpton@fanshaweonline.ca
Reference: Course material for Fanshawe College MGMT 6060
Meetings: by appointment; after class preferred

© David Sumpton 2021

Making decisions under uncertainty: a
framework
 Decision
making
Decision making under uncertainty: what can happen

Situation happens We see a problem or an opportunity

Our project
We collect information Based on what we think we know

We think about it As much emotional, as logical

Our thinking We might ask for advice From supervisors, friends, colleagues

We decide what to do Take action

Results are delivered Ideally, the results are to our liking

Things happen
3 Good or bad outcomes? OR we’re surprised: what happened?
 Decision
making
Making decisions under uncertainty: emotions vs. logic

• What’s the immediate issue? Longer term issue?

Identify critical
– What is the relative importance and urgency?
issues
– Do we even know we have a problem? Or an opportunity?

Define the • Define problem (s) to be solved, and possible constraints

problem – What might OTHER people see as the issue? (cognitive diversity)

• What information might exist? Can we get it, and when?

Analyze issues • Analyse information, and whether our assumptions should change
– What are the causes of problems and concerns?
• Create alternatives: what might be the likely outcome?

• Define decision criteria & priorities: legal, ethical, fairness

Make a decision – Consider risk tolerance (not risk acceptance)
• Select preferred action; predict likely outcome & timing

• Obtain approvals; implement solution

Take action
– 30, 60, 90 day action plan; evaluate effectiveness
4
Adapted from Andrews et al, “Canadian Professional Engineering & Ethics 6th ed”, 2019, P. 222; Leenders et al, “Learning with Cases, 4th ed”, 2014
Economic Value
 Cash flows
Economic value: Business definition

• Economic value may be defined as the measurement of a benefit

Economic value provided by a good or service; usually measured in currency
• Value is created when economic benefits are created & measured
• Benefits may be delivered now, or in the future

• More assets, more equity, less liability (subject to growth goals)

Ideal business
– Asset: Economic resource, from which future economic benefits
goals
will flow to the business
– Liability: Obligation, the settlement of which is an outflow of
economic resources and future benefits
– Equity: Resources minus Obligations

• Profit = Income minus Expenditures, after tax

Delivering
• Equity = Assets minus Liabilities
economic value

6
Economic benefits and value: Draft Guidelines on Sustainable Development, www.theiam.org, pending publication. David Sumpton et al.
Asset, liability, equity definitions: https://www.ifrs.org/issued-standards/list-of-standards/, accessed May 2021
 Cash flows
Goal: positive cash flow; benefits to society + environment
Economic Value

Bad outcomes, but Positive cash flow,

still financially good benefits for
viable all

Social and
— + Environmental
benefits

Beneficial but
Bad projects
unaffordable

Created with Mallora Rayner, https://worldofwalas.com/

—
Cash flows: the cash flow statement

- All businesses must publish cash flows & other required

financial statements
- All projects must forecast their cash flows, and the
resultant benefits to the business
- Depending on the financing circumstances, the project can also
define its own forward-looking financial statements
 Definitions
Cash flows: definitions
• Cash on hand, demand deposits
Cash
• Short-term, highly liquid investments: readily convertible to cash;
Cash – Insignificant risk of changes in value, e.g. Gov’t treasury bills
equivalents
• Cash generated from operations, minus capital expenditures
Free cash flow
• “A statement of cash flows, when used in conjunction with the
Statement of rest of the financial statements, provides information that enables
cash flows users to evaluate the changes in net assets of an entity, its
financial structure (including its liquidity and solvency) and its
ability to affect the amounts and timing of cash flows in order to
adapt to changing circumstances and opportunities.” IAS 7

• Exclude from cash flow statement, disclose in other Statements:

Non-cash – Acquiring assets by assuming liabilities, or leasing
transactions – Acquiring of entities by issuing equity
– Converting debt to equity
9
International Accounting Standard IAS 7 Statement of Cash Flows, 2021
https://www.ifrs.org/issued-standards/list-of-standards/, accessed May 2021
 Definitions
Cash flows, operating activities: definitions

Operating • “Principal revenue-producing activities of the entity and other

activities activities that are not investing or financing activities,” IAS 7

• “Key indicator of the extent to which operations of entity have

Purpose generated sufficient cash flows to repay loans, maintain operating
capability, pay dividends, and make new investments without
recourse to external sources of financing.” IAS 7

Generally include transactions which enter into P&L computation:

Examples • Receipts from sale of goods, commissions, fees, services
• Payments to suppliers for goods & services
• Salaries and wages paid to employees

10
International Accounting Standard IAS 7 Statement of Cash Flows, 2021
https://www.ifrs.org/issued-standards/list-of-standards/, accessed May 2021
 Definitions
Cash flows, investing activities: definitions

Investing • “Acquisition and disposal of long-term assets and other

activities investments not included in cash equivalents.” IAS 7

• “Represent the extent to which expenditures have been made for

Purpose resources intended to generate future income & cash flows..” IAS 7

• Acquisitions of property, plant and equipment; and intangibles

Examples • Cash receipts from sale of above
• Purchase or sale of equity or debt instruments in other companies
– Stocks, debt, mergers & acquisitions
• Purchase or sale of financial instruments intended to generate
additional income
– Futures contracts, options, swaps

11
International Accounting Standard IAS 7 Statement of Cash Flows, 2021
https://www.ifrs.org/issued-standards/list-of-standards/, accessed May 2021
 Definitions
Cash flows, financing activities: definitions

Financing • “Activities that result in changes in the size and composition of the
activities contributed equity and borrowings of the entity.” IAS 7

• “ Useful in predicting claims on future cash flows by providers of

Purpose capital to the entity.” IAS 7

• Cash from issuing shares

Examples • Payments to owners to repurchase shares
• Proceeds from issuing bonds and debt to investors
• Proceeds from bank loans, mortgages
• Repayments of amounts borrowed

Alternative Separately disclose, consistently categorize particular financing acts:

treatment • Dividends received, interest received
– Can also be considered operating or investing activities
• Interest paid, dividends paid
– Can also be considered operating activities
12
International Accounting Standard IAS 7 Statement of Cash Flows, 2021
https://www.ifrs.org/issued-standards/list-of-standards/, accessed May 2021
 Financial
Statement of Cash Flows: sources & uses of cash statements
Operating activities
+ Net income X1 Revenue minus Expense
+ Non cash expenses, and deferred taxes X2 Depreciation
Customers paid bills, we used up inventory, or
+ Decrease in current assets; increase in current liabilities X3
we bought items on short-term credit
We extended credit to customers, or we paid
– Increase in current assets; decrease in current liabilities X4
our bills
꓿ Cash from operations XXX
Investing activities
– Purchase of investments X5 Purchased stocks, bonds of another company
+ Sale of investments X6 Sold the above
Purchased, constructed or created assets with
– Capital investments (property, plant and equipment) X7
economic life > 1 year; most ‘project’ costs
– Acquisitions (of other entities) X8 Purchased another company
꓿ Cash from investing activities YYY
Financing activities
+ Sale of stock A1 Sold stock to our shareholders
– Repurchase of stock, dividend payments A2 Paid our shareholders
+ Debt issuance A3 Obtained long-term debt > 1 year
– Debt reduction A4 Paid principal of long-term debt
꓿13 Cash from financing activities ZZZ
 Cash flows
Project Cash Flows & economic cash equivalents
Cash In Cash Out

• Revenues • Property, plant, equipment

(capital investments)
• Savings: remove from budget *
‒ Capital • Operating costs (expense)
‒ Expense
• Overhead cost allocations
• Potential savings: e.g. risk (indirect expense) *
reduction *
• Taxes
• Financing proceeds
‒ Shareholders • Financing costs
‒ Creditors ‒ Shareholder dividends
‒ Gov’t Grants ‒ Principal & interest payments

• Potential revenue protection * • Opportunity costs *

– Benefits foregone by not investing in
another project
• Re-use existing assets * – Re-use of existing assets which could
– Some ‘sunk costs’ can be recouped
have been re-used elsewhere
14
* Economic cash equivalent Created with Mallora Rayner, https://worldofwalas.com/
 Cash flows
Selected Financial & Economic measures
Financial

• Net profit margin Where applicable:

• Pro Forma Financial Statements
• Return on Equity (ROE)
• Effects / Synergies on other
• Accounting Rate of Return projects, operating activities;
other related businesses
• Free Cash Flow (FCF)

Economic – use with care

• Net present value (cash flows discounted at weighted average cost of capital)

• Payback period

• Benefit / cost ratio

• Activity-based measures: cost, resource usage, pollution, customer satisfaction…

15
 Cash flows
Selected Economic & Financial measures - details
Financial
Net income after tax
Net profit margin
Revenue (or Sales)
Net income
Return on Equity (ROE)
Average equity for period
Average net income/year
Accounting Rate of Return
Total investment, initial & any upgrades

Free Cash Flow (FCF) Cash from Operations − Capital Expenditures

Economic – use with care

𝑛
Net cash flow, period 𝑡
Net present value ෍ , 𝑖 = Cost of Capital
1+𝑖 𝑡
𝑡=0

When cash flow becomes

Payback period
positive: months or years
NPV of all future cash flows
Benefit / cost ratio
16 NPV initial investment & any upgrades
End of module 11