Topic 5: Cash Flow

Definition
• Cash flow is the net amount
of cash and cash-equivalents being
transferred into and out of a business. At the
most fundamental level, a company's ability to
create value for shareholders is determined by
its ability to generate positive cash flows, or
more specifically, maximize long-term
free cash flow (FCF).
 Example
• Cash Flow from Investing Activities
is cash earned or spent from investments your
company makes, such as purchasing
equipment or investing in other
companies. Cash Flow from Financing
Activities is cash earned or spent in the course
of financing your company with loans, lines of
credit, or owner's equity.
 Cash flow Calculation
• Cash flow formula:
• Free Cash Flow = Net income +
Depreciation/Amortization – Change in Working
Capital – Capital Expenditure.
• Operating Cash Flow = Operating Income +
Depreciation – Taxes + Change in Working Capital.
• Cash Flow Forecast = Beginning Cash + Projected
Inflows – Projected Outflows = Ending Cash.
 Types of cash flow
• The statement of cash flows presents sources
and uses of cash in three distinct categories:
cash flows from operating activities, cash
flows from investing activities, and cash flows
from financing activities.
 Investment fund
• An investment fund is a pool of capital that a
number of individual investors pay into, which
is used to collectively invest in stocks and
bonds. The two main types of investment
fund are open-ended and closed-ended.
 Net present value (NPV)
• Net present value (NPV) is the difference between the
present value of cash inflows and the present value of
cash outflows over a period of time. NPV is used in
capital budgeting and investment planning to analyze
the profitability of a projected investment or project.
• It is calculated by taking the difference between the
present value of cash inflows and present value of
cash outflows over a period of time. As the name
suggests, net present value is nothing but net off of
the present value of cash inflows and outflows by
discounting the flows at a specified rate.
 Good investment
• NPV > 0: The PV of the inflows is greater than
the PV of the outflows. The money earned on
the investment is worth more today than the
costs, therefore, it is a good investment.
... NPV < 0: The PV of the inflows is less than
the PV of the outflows.
 Internal Rate of Return (IRR)
• IRR is the annual rate of growth an investment is
expected to generate. IRR is calculated using the
same concept as NPV, except it sets the NPV
equal to zero. IRR is ideal for analyzing capital
budgeting projects to understand and compare
potential rates of annual return over time.
• The IRR equals the discount rate that makes the
NPV of future cash flows equal to zero. The IRR
indicates the annualized rate of return for a given
investment—no matter how far into the
future—and a given expected future cash flow.
• Generally, the higher the IRR, the better.
However, a company may prefer a project
with a lower IRR because it has other
intangible benefits, such as contributing to a
bigger strategic plan or impeding competition.
• The internal rate of return (IRR) is a core
component of capital budgeting and
corporate finance. Businesses use it to
determine which discount rate makes the
present value of future after-tax cash flows
equal to the initial cost of the capital
investment.
 Advantage of NPV over IRR
• The advantage to using the NPV method
over IRR using the example above is
that NPV can handle multiple discount rates
without any problems. Each year's cash flow
can be discounted separately from the others
making NPV the better method.
 Task:
• Read Title 5 : Cash Flow in Matematik
Kewangan module
• Do the Latihan kendiri 5.1 (Question 1 to 4)