Financial Management

Dr. Eslam Abd El-Hamid

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Cash Flow Statement
 3. CASH FLOW STATEMENT

• The third critical financial statement, along with the balance

sheet and the income statement, is called the statement of
cash flows, which is a more accurate description of the
information it contains.
• It describes in summary form how the company generated the
cash flows it needed (sources) to finance its various financial
opportunities and responsibilities (uses) during the past year.
 3. CASH FLOW STATEMENT

• There are three main components of the statement of cash

flows. They are the following:
– Cash flow from operations
– Cash flow from investing
– Cash flow from financing
 3. CASH FLOW STATEMENT

• What Does A Cash Flow Statement Tell You?

– Cash is the fuel that runs your business. Running out of it would be
disastrous, so you must have a “cash flow” or money on hand to pay
bills and meet day-to-day expenses. Keep in mind that companies can
produce a profit, but still not have a positive cash flow.
– The Cash Flow Statement shows money that comes into the business,
money that goes out and money that is kept on hand to meet daily
expenses and emergencies.
 CASH FLOW STATEMENT
▪ The statement of cash flows integrates the information contained in the balance sheet and income statement
in a manner that allows an analyst to determine what the sources and uses of cash for a firm.
▪ The cash flow statement including:
1) Cash flow from Operating Activity: This section of the statement of cash flows lists the sources and uses of
cash that arise from the normal operations of a firm.

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 CASH FLOW STATEMENT
2) Cash flow from investing Activity: This section of the statement of cash flows lists the sources and
uses of cash that arise from the investing activities of a firm (generally related to long-term assets).
▪ Investing activities include:
▪ Borrowing or Repayment Debt
▪ buying and selling securities of other firms, and
▪ buying and selling property, plant, and equipment.

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 CASH FLOW STATEMENT
3) Cash flow from Financing Activity: This section of the statement of cash flows lists the sources and uses of
cash that arise from the financing activities of a firm (generally related to long-term liabilities and equity).
▪ Financing activities include:
▪ sales and repurchases of the firm’s equity,
▪ dividends to the firm’s stockholders, and
▪ issuances and retirements of the firm’s debt.

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 CASE 5 – CASH FLOW

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 INTERRELATION BETWEEN DIFFERENT STATEMENTS

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Module three:
Financial Analysis
 LIQUIDITY RATIO ANALYSIS
✔ LIQUIDITY RATIOS:
▪ The liquidity of a firm is measured by its ability to satisfy its short-term obligations as they come
due. These ratios can provide early signs of cash flow problems and impending business failure, so
having enough liquidity for day-to-day operations is important.
▪ Liquid assets, like cash held at banks do not earn a particularly high rate of return, so shareholders
will not want a firm to overinvest in liquidity. Firms have to balance the need for safety against
the low returns that liquid assets generate for investors.
▪ Liquidity Indicators are:
✔ Current Ratio
✔ Quick Ratio
✔ Working Capital

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 LIQUIDITY RATIOS – CONT’D

WORKING CAPITAL Working Capital = Current Assets - Current Liabilities

▪ Working capital, reflect the company’s ability to cover the short term obligations,
but it is not very useful in comparison as it is stated in an absolute figure.

CURRENT RATIO Current Ratio = Current Assets ÷ Current Liabilities

▪ This is another indicator of the company’s liquidity, but it is indicated in (Times =
2:1), this gives more clear picture about company’s ability to settle obligations.
▪ Low ratio, indicate a possible solvency problem.
▪ A Very high ratio, is not always a good indicator, more investigation is needed to
find out whether:
✔ There is extra cash (idle investment)
✔ May me there is a problem in handling the working capital cycle.
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 LIQUIDITY RATIOS – CONT’D

QUICK RATIO Quick Ratio = Quick Assets ÷ Current Liabilities

*Quick Assets = Current Assets – Inventory – Prepaid Expenses

▪ This ratio measures the company’s ability to settle its obligation from its most
liquid assets, it is stated in terms of (Times 1:1).
▪ Inventory is not considered as a Quick Assets, where we still need to wait un till it
is sold or (manufactured & sold) and then collected
▪ Pre-paid expenses also is not considered to be Quick Assets, as it is not expected to
be converted into cash, it is an early payment for up-coming liability.

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 LIQUIDITY RATIOS – CONT’D
❑ Example:
▪ Kindly Compute the following for each ITEM Company "A" Company "B"

company and then compare:

Current Assets
✔ Working Capital Cash 1,000,000 500,000
✔ Current Ratio Customer Receivables 5,000,000 1,500,000

✔ Quick Ratio Pre-paid Expenses 250,000 0

Inventory 3,750,000 3,000,000
Total Current Assets 10,000,000 5,000,000

Current Liabilities:
Suppliers Payables 3,500,000 1,500,000
Short Term Banking Facilities 1,500,000 1,000,000
Current Portion Of Long Term Debt 1,000,000 0
6,000,000 2,500,000

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 DEBT RATIO ANALYSIS
✔ DEBT RATIOS:
▪ Debt Ratios; give users a general idea of the company's overall debt load as well as its mix of
equity and debt. Debt ratios can be used to determine the overall level of financial risk a company
and its shareholders face. In general, the greater the amount of debt held by a company the
greater the financial risk of bankruptcy.
▪ In general, the financial analyst is most concerned with long-term debts because these commit
the firm to a stream of contractual payments over the long run.
▪ Because creditors’ claims must be satisfied before the
earnings can be distributed to shareholders, current and
prospective investors or creditors pay close attention to the
firm’s ability to repay debts

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 DEBT RATIOS ANALYSIS – CONT’D

DEBT TO ASSETS RATIO (D/A) Debt Ratio = Total Liabilities ÷ Total Assets

▪ Debt Ratio, measures the proportion of total assets financed by the firm’s
creditors. The higher this ratio, the greater the amount of other creditor’s money
being used to run the business and generate profits.

DEBT TO EQUITY RATIO (D/E) Debt To Equity Ratio = Total Liabilities ÷ Total Owners’ Equity

▪ Debt-Equity Ratio; compares a company's total liabilities to its total shareholders'

equity. This is a measurement of how much suppliers, lenders, creditors and
obligors have committed to the company versus what the shareholders have
committed

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 DEBT RATIOS ANALYSIS – CONT’D

TIE Ratio = EBIT ÷ Interest Expenses

INTEREST COVERAGE RATIO
OR TIMES INTEREST *EBIT = Earning Before Interest & Taxes
EARNED “TIE”
▪ TIE ratio; measures the firm’s ability to fulfill its interest obligations, the higher this
ratio is the better. Alternatively the lower the more risky the firm is, if the firm is
unable to pay interest dues, this means that it is in default and is not able to take
any extra debt financing, & in the mean time current creditors may seek
immediate payment.

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 DEBT RATIOS ANALYSIS – CONT’D

DSCR = Net Operating Income ÷ Debt Service

DEBT SERVICE COVERAGE
*Net Operating Income = Net Income + Interest Expense + Depreciation &
RATIO (DSCR)
Amortization + Other Non Cash Expenses
** Debt Service = Interest Payment + Principle Payments + Lease Payments

▪ DSCR; measures the firm’s ability to produce enough cash to cover its debts
obligations including lease payments
▪ DSCR less than “1”, indicates that the expected generated cash will not be able to
cover the debts obligations, this put the firm in high risk.

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 DEBT RATIOS ANALYSIS – CONT’D
❑ Example: ITEM Company "A" Company "B"

▪ Kindly Compute the following for each

Balance Sheet
Assets Y-15 Y-15
company and then compare:
Current Assets 15,000,000 12,000,000
✔ D/A Ratio Fixed Assets 35,000,000 26,000,000

✔ D/E Ratio Liabilities: Y-15 Y-15

✔ TIE Ratio
Current Liabilities 5,000,000 8,000,000
Long Term Liabilities 10,000,000 10,000,000
✔ DECR Ratio Shareholders Equity Y-15 Y-15
Paid In Capital 25,000,000 16,000,000
Retained Earnings 10,000,000 4,000,000

Section From Balance Sheet Y-15 Y-15

EBIT 3,800,000 2,125,000
Interest Exp 285,000 127,500
Taxes 703,000 399,500
Depreciation Exp 570,000 255,000
Long Term Annual Installment 1,000,000 1,000,000
Lease 500,000 1,000,000

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 PROFITABILITY RATIO ANALYSIS
✔ PROFITABILITY RATIOS:
▪ Profitability Ratios; these measures evaluate the firm’s profits with respect to a given level of
sales, a certain level of assets, or the owners’ investment. Without profits, a firm could not attract
outside capital. Owners, creditors, and management pay close attention to boosting profits .
▪ Profits indicates that there will be extra cash to be injected in the business, which simple means
that the company will still be able to sustain running business.
▪ Some Profitability Indicators:
▪ Gross Profit Margin
▪ EBITDA Margin
▪ EBIT Margin
▪ Net Income Margin
▪ Return On Assets “ROA”
▪ Return On Equity “ROE”
▪ Earning Per Share “EPS”
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 PROFITABILITY RATIOS ANALYSIS – CONT’D

GROSS PROFIT MARGIN Gross Profit Margin = Gross Profit ÷ Net Sales
▪ Gross Profit margin, a financial metric used to assess a firm's financial health by
revealing the proportion of money left over from revenues after accounting for the
cost of goods sold. Gross profit margin serves as the source for paying additional
expenses and future savings .

EBITDA MARGIN EBITDA Margin = EBITDA ÷ Net Sales

*EBITDA = Earning Before Interest Taxes Depreciation Amortization

▪ As EBITDA, exclude the effect of interest bearing financing activities, in addition to

the depreciation & amortization (non-cash expense), it is useful to give you a clear
indication about management capability to run their business without financing
effects
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 PROFITABILITY RATIOS ANALYSIS – CONT’D

EBIT Margin = EBIT ÷ Net Sales

EBIT MARGIN
*EBIT = Earning Before Interest Taxes

▪ EBIT margin, a financial metric used to assess a firm's financial viability to run the
business including the fixed assets usage, and on the other hand excluding the
financing bearing interest decisions.

NET PROFIT MARGIN Net Profit Margin = Net Profit ÷ Net Sales

▪ The Net Profit margin is intended to be a measure of the overall success of a

business. A high net profit margin indicates that a business is pricing its products
correctly and is exercising good cost control.

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 PROFITABILITY RATIOS ANALYSIS – CONT’D

RETURN ON ASSETS ROA = Net Profit ÷ Average Total Assets

“ROA”
▪ ROA, it indicates how profitable a company is relative to its total assets. The return
on assets (ROA) ratio illustrates how well management is employing the company's
total assets to make a profit. The higher the return, the more efficient
management is in utilizing its asset base. The ROA ratio is calculated by comparing
net income to average total assets, and is expressed as a percentage.

RETURN ON EQUITY ROE = Net Profit ÷ Average Shareholders Equity

“ROE” ▪ ROE indicates how profitable a company is by comparing its net income to its
average shareholders' equity. ROE measures how much the shareholders earned
for their investment in the company. The higher the ratio percentage, the more
efficient management is in utilizing its equity.

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 PROFITABILITY RATIOS ANALYSIS – CONT’D

EARNING PER SHARE EPS = (Net Profit – Dividends On Preferred Stock) ÷ Average Common Share Outstanding
“EPS”
▪ EPS, is the portion of a company's profit allocated to each outstanding share of
common stock
▪ It is more accurate to use the weighted average number of shares during the
reporting period.

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 PROFITABILITY RATIOS ANALYSIS – CONT’D
❑ Example:
ITEM Company "A" Company "A"
▪ Kindly Compute the following for each
Item Y-14 Y-15
company and then compare:
Net Sales 33,500,000 37,687,500
✔ Gross Profit Margin
Cost Of Goods Sold 23,450,000 27,135,000
✔ EBIT Margin
General Expenses 2,680,000 3,391,875
✔ EBITDA Margin Interest 502,500 565,313
✔ Net Income Margin Taxes 1,373,500 1,319,063
✔ ROA Net Income 5,494,000 5,276,250

✔ ROE 1) Depreciation & Amortization 1,340,000 1,507,500

✔ EPS 2) Fixed Assets 15,000,000 17,000,000

3) Shareholders Equity 25,494,000 30,770,250

4) Common Shares Number 2,000,000 2,000,000

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 ACTIVITY RATIO ANALYSIS
✔ ACTIVITY RATIOS:
▪ Activity Ratios, measures the speed by which companies is using its operating assets to be
converted into sales & cash .
▪ Activity Ratios reflect the company’s efficiency in operating a variety of dimensions like inventory
/ receivables / payables (commercial side of the business).
▪ Also Activity Ratios can be used to measure how effective is the usage of fixed assets to
generated sales.
▪ Some Activity Indicators are:
✔ Inventory Turnover
✔ Days Sales Out Standing
✔ Days Inventory Outstanding
✔ Days Payable Outstanding
✔ Fixed Assets Turnover
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 ACTIVITY RATIO ANALYSIS – CONT’D

✔ ACTIVITY RATIOS:
▪ To Calculate the Activity Ratios we need to get several items from Financial Statement:
a. Revenues & Cost Of Goods Sold from Income Statement.
b. Beginning & Ending Inventory from Balance Sheet.
c. Beginning & Ending Customer Receivables from Balance Sheet.
d. Beginning & Ending Supplier Payable from Balance Sheet.
e. The number of days for the period (Period = 360 days / Period = 90 days)

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 ACTIVITY RATIOS ANALYSIS – CONT’D

INVENTORY TURNOVER Inventory Turnover = COGS ÷ Average Inventory

*Average Inventory = (Beginning Inventory + Ending Inventory ) ÷ 2

▪ Inventory Turnover is a ratio showing how many times a company’s is sold and
replaced over a period.

DAYS INVENTORY DIO = (Average Inventory ÷ COGS) / 360

OUTSTANDING “DIO” *Average Inventory = (Beginning Inventory + Ending Inventory ) ÷ 2

▪ DIO measures the average number of days the company holds its inventory before
selling it. The ratio measures the number of days funds are tied up in inventory

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 ACTIVITY RATIOS ANALYSIS – CONT’D

DSO = (Average Receivables ÷ Revenues) / 360

DAYS SALES OUTSTANDING
“DSO” *Average Receivables = (Beginning Receivables + Ending Receivables ) ÷ 2

▪ DSO measures the number of days the company takes to collect its sales, it can be
used to assess the company’s credit policy.

DPO = (Average Payables ÷ COGS) / 360

DAYS PAYABLE
OUTSTANDING “DPO” *Average Payables = (Beginning Payables + Ending Payables ) ÷ 2

▪ DPO measures the average number of days the company takes to pay its bills from
trade suppliers

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 ACTIVITY RATIOS ANALYSIS – CONT’D

CCC = DIO + DSO – DPO

CASH CONVERSION CYCLE ▪ CCC as a stand alone number does not mean very much, it should be used to track
“CCC”
the company over a period of time & to compare the company to its competitors
▪ CCC reflects the effect of company’s selling / purchasing policy, production process
& their effect on cash cycle
▪ CCC used to determine & match the company’s required short term facilities
(working capital facilities) in terms of tenor & amount

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 ACTIVITY RATIOS ANALYSIS – CONT’D
❑ Example:
ITEM Company "A" Company "B"
▪ Kindly Compute the following for each
Section From Balance Sheet
company and then compare: Current Assets Average Average
✔ DIO
✔ DSO Customer Receivables 4,500,000 1,500,000
Inventory 2,550,000 1,250,000
✔ DPO
✔ CCC Current Liabilities: Average Average
Suppliers Payables 2,550,000 1,875,000

Section From Income Statement Y-14 Y-15

Revenues 30,600,000 18,000,000
Cost Of Goods Sold 30,600,000 15,000,000

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 WORKING CAPITAL & THE CASH CONVERSION CYCLE
❑ WORKING CAPITAL :
✔ Is the cash required to finance the day to day operations of the business to be able to:
▪ To pay your Suppliers when invoices come due
▪ Allow your customers to buy now and pay later
▪ To pay employees and other creditors
✔ In other words it is the length of time it take to convert business current assets (inventory and sales
receivables) and current liabilities (suppliers payables) into cash and it is measured by the cash
conversion cycle which is composed of:
▪ Days Sales Outstanding “DSO”; average time taken to collect the customers receivables.
▪ Days Inventory Outstanding “DIO”; average time taken to produce business inventory and convert it
into sales.
▪ Days Payable Outstanding “DPO”; average taken to pay your suppliers.

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 WORKING CAPITAL & THE CASH CONVERSION CYCLE

OPERATING CYCLE “OC”:

OPERATING CYCLE “OC”:

OC = DIO + DSO
OC = 60 + 40 = 100 Days

CASH CONVERSION CYCLE “CCC” :

CASH CONVERSION CYCLE “CCC”:

CCC = OC - DIO
CCC = 100 - 35 = 65 Days

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 WORKING CAPITAL & THE CASH CONVERSION CYCLE
✔ Working Capital Optimization is not only the function of the Finance Department, it is a cross functional
process where it affects different departments of the organization where the main objective is to:
▪ Keep minimum cash tied up in the working capital cycle
▪ Preserve sufficient cash to cover business due payments
▪ Have an efficient and effective service level
PERFORMANCE DEPARTMENT IN
MEANING DRIVEN BY
INDICATOR CHARGES
▪ Sales ▪ Payment Terms
Days Sales Outstanding How long does it take to
▪ Finance ▪ Invoice Issuance Timeline
“DSO” collect your receivables?
▪ Credit ▪ Collection Effectiveness
▪ Sales
▪ Inventory Policies
Days Inventory Outstanding How long does it take to ▪ Production
▪ Forecast Accuracy
“DIO” consume the inventory? ▪ Supply Chain &
▪ Distribution Effectiveness
Distribution
How long does it take to pay ▪ Procurement ▪ Payment Terms
Days Payables Outstanding
your payables? ▪ Finance ▪ Payment Discounts
“DPO”
▪ Payment Methods

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 CASE 6 – FINANCIAL ANALYSIS

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