Cash Flow Analysis

GLIM
Dr. Manaswee K Samal
 Analysing cash flows
Framework
Statement of cash Cash from Cash flow analysis
flows: operations: Reporting limitations
Relevance of Indirect method Cash flows and
cash accruals
Direct method
Reporting by Alternative measure
activities
Business conditions
Constructing the
statement Free cash flow
 Relevance of CFS
• Helps in assessing liquidity, solvency and financial flexibility
[ability to adjust]
• How much cash is generated from or used in operations?
• Cash expenses
• How dividends are paid in case of loss?
• Source of cash for debt payments
• How is increase in investments financed?
• What is source of new asset acquisition?
• Why is cash lower when income has increased?
• What is the use of cash received from new financing?
 Reporting by activities
Cash receipts and payments under
- Operating activities: working capital items and
income statement items (except non-
operating items)
- Investing activities: assets expected to
generate income and investments
- Financing activities: contributing, withdrawing
and servicing funds (dividend)
 Why disclose under three heads?
• Operating activities- useful in forecasting
future operating cash flows
• Investing activities- expenditure made in
resources to generate future income
• Financing activities- predicting claims on
future cash flows by providers of funds
Preparation of statement of cash flows
• Indirect method: net income is adjusted for non-cash
income (expense) items and accruals – helps in
relating income to cash; helps in predicting income
then relating income to cash (most commonly used
method)
• Direct method: each item is adjusted for its accruals
Under both the methods, cash flow from financing
and investing activities computed in the same
method.
Only cash from operations is computed in different
manner.
 Net cash from operations
Net Income
+ Depreciation & amortisation
+/- Increase (Decrease in DTL)
- Gains on sale of assets/investments
+ Loss on sale of assets/investments
+/- Cash generated by current assets and
liabilities
 Limitations
No uniformity
Discontinued operations- separate disclosure
Income tax is reported as operating cash flow
(should relate to all three activities)
 Analysis
• Source of assets replacement
• Source of expansion and business acquisition
• Degree of dependence on external financing
• Investing demands and opportunities
• Requirements and types of financing
• Sensitiveness of managerial policies like
dividend to cash flow
 Inferences
• Quality of management’s decisions:
Business acquisitions/expansions/ time lag of cash flow

Asset sale/acquisition – impact on cash flow; where it

committed resources, where it reduced investments,

Where claim was reduced, etc.

• Disposition of earnings and investment of discretionary

cash flow
 Cont..
• Size, composition, pattern and stability of cash
flow

• Judging stability: Increase in cash flow due to

securitisation, reduction in inventory, increase
in payables (represents deferred cash outflow)
may not be sustainable
 Company and Economic Conditions
• Both successful and unsuccessful companies
experience cash problems- nature is different
How?
Increase in receivables
Increase in inventories
Profit
More equity and debt
 What does cash flow validate?
• Prediction of operating results on the basis of
acquired and planned productive capacity
• Assessment of future expansion capacity,
capital requirements
• Current obligations
• Connection between income statement and
balance sheet
 Cont…
• Capex feasibility
• Cash source of expansion
• Future dividend policies
• Debt servicing
• Quality of earnings
• Financial flexibility in adversity
 Analysis of cash flow
• Cash realisation ratio=
Cash from operations/Net income

A higher ratio means higher quality ratio.

CRR > I: what if by stretching accounts payable?
 Coverage ratios
• DSCR and Interest coverage ratio: if numerator
can be cash from operations

[CFO+ Cash payment for interest + Tax] /

Interest
 Asset efficiency ratio
• CFO/Total operating assets
 Capital Asset ratio
[CFO + Cash inflows from asset disposal –
Dividend paid] / Cash outflow for asset
acquisition
 Creditworthiness ratio
• Cash generated by operations /[Short-term &
Long-term debt]
For highest credit rating, it should be 1:1
 Cash flow adequacy ratio
Measures ability to generate sufficient cash from
operations to cover capex, investment in inventories,
dividend
3-year period is taken to weed out cyclical fluctuation
= 3-yr sum of cash from operations / 3-yr. sum of capex,
inventory addition, dividend
Other current assets are excluded as they are financed
primarily by short-term credit
Reveals cash financing of growth
 Cash reinvestment ratio
Measure of the percentage of investment in
assets representing operating cash retained
and reinvested in the company for both
replacing assets and growth in operations
=[ operating cash flow – dividend] / investment
in gross plant + investment + other assets +
working capital
 Current liability coverage ratio
= [CFO – Cash dividend paid] / CL
 Long term debt coverage ratio
• = [CFO – Cash dividend paid] / LTD
 Cash generating power
• CFO / [CFO + CFI + CFF]
 External financing ratio
• CFF/CFO
• A larger ratio is undesirable
 Operating cash margin
• CFO/Sales
• EBITDA/Sales
 Cash flow per share
• [CFO – Preference dividend] / No. of equity
shares
 FCFF
• Not a GAAP number
• Represents cash for unlevered firms
• Used for valuing a firm (DCF technique)
• Can be calculated taking EAT or EBIT or CFO
 Four ways to get FCFF
• EAT + DEP + I (1-t) –Change in WC other than cash-CAPEX

• EBIT – tax on EBIT + DEP – Change in WC other than cash –

CAPEX
• EBITDA(1-t) + DEP(tax rate) - Change in WC other than cash
– CAPEX

• CFO – Tax shield on Interest - CAPEX