Cash Flow &

Ratio Analysis
 Learning Goals
► Why and how Cash flows are important for an
investment decision.
► Understanding the Statement of Cash flow
► Deriving Income and Expense statement including
assumption
► Concept of Cash-flow-Conceptualise, Analyse,
Realise, Channelise, Materialise
► Understanding Liability as a source of Cash flow
► Understanding ratio and their importance
Why and how CFs are important for
an investment decision…
► A cash flow statement is one, which has outflows and
inflows of cash. Here only cash transactions are
considered.
► Cash includes cheques deposited or drawn from bank
accounts. Here the cash flows include both fixed and
variable ones and also regular and irregular cash income /
expenses.
► Earnings and other forms of receipts such as gifts,
lotteries, etc. create cash inflows.
► Application of funds into expenses or investments result
into outflows.
 Assets
► Cash / Near Cash (also known as cash equivalent)
 Bank Accounts: Savings/ Current account
 Fixed deposits
► Invested Assets
 Stock Holdings
 Mutual Fund Investments
 Property
 Owned Businesses
 EPF and PPF savings
► Personal Use Assets
 Place of residence
 Cars and other vehicles
 Personal assets as listed above
 Valuation of Assets
► Assets must be valued at fair market value when
creating the Statement of Net Worth.
► Fair market value is either the actual listed value
of the asset or the price at which the asset can be
sold for, in the open market.
► Where the fair market value cannot be easily
assessed, it is prudent to use Cost after reducing a
reasonable amount to account for wear and tear,
i.e., depreciation.
 Liabilities
► Current Liabilities
 Current liabilities arise from the charges for the purchase of
consumable goods and services, and are generally due within 1
year or earlier from the date of creating the same. Examples of
current liabilities are as follow:
► Outstanding balance on credit card
► Short-term loans outstanding
► Bank overdraft or credit line

► Long-term Liabilities
 When Debt obligations with final repayment dates beyond a year
are created, they are classified as long-term liabilities. Examples
of long-term liabilities are as follow:
► Home mortgage balance outstanding
► Long-term loans outstanding e.g. car loan
 Creation of Balance sheet / Net
worth Statement
► Step 1: List out all Cash Flows: Inflow and Outflows
► Step 2: Classify them as:
Revenue: Income, Expenses,
Capital: Investments and Loans Receipts or Repayments.
► Step 3: Incorporate the Capital Flows into a Statement of
Assets and Liabilities.
► This statement of Assets and Liabilities will then simplistically
constitute a Balance Sheet, which summarizes an individual's
financial statement at that point in time by differentiating:
 What a person owns the assets, against
 What he owes the liabilities or debt, and
 What he is worth his net worth

NET WORTH = ASSETS – LIABILITIES

 Understanding the Statement of
Cash flow
► Net Cash Flow is the difference between cash inflows and
outflows.
Net Cash Flow = Cash Inflow - Cash Outflow
► The net cash flow may be positive, negative or zero.
► When we have +ve Cash flow = Cash Inflows > Cash
Outflows
► When we have -ve Cash flow = Cash Outflows > Cash
Inflows
► When we have Zero Cash flow = Cash Inflows = Cash
Outflows
 Contd.
► The Cash flow statement indicates the following:
 The spending pattern that the individual follows.
 Identify if the individual is over spending.
 Helps allocate resources more effectively.
 Helps the individual understanding where his money
comes from and where it goes.
 The net cash flow if positive is indicated
 Cash Flow Concept

INVESTMENT
VEHICLE:
Investor Objective
Business, Equity,
Stake holder

► Investment is just like starting up a new business where

objective is to earn profit.
 The Framework…

Income from Income from

When you start saving: Man at Work > Money at Work

Income from < Income from

What you aim for is: Man at Work Money at Work
 Summary…
► Analyze: Whether it is positive, or negative or zero and how this can
be changed by reorganizing current allocations. Analyse the Cash
Flows:
 Is it +ve or -ve or =?
 Are the cash flows predictable or erratic?
 Which are the peaks and valleys?
 Are all the tax shelters availed or do they pay too much tax?
 What are the liabilities and the interest cost of servicing these liabilities?
► Realize: these into provisions for investments through a process of
forecasting and budgeting so that there is adequate provisioning for
applicable outflows into solutions that meet their objectives.
► Channelize: These savings into financial plans that help the customer
meet his financial objectives.
► Materialize: The ensuing cash flows result into enhanced wealth
creation as well as meet financial objectives sooner than expected.
 Ratio & their Importance
► The commonly used tool to analyse or
interpret these statements better is “Ratio
Analysis”.
► Ratio is a relationship between two
variables. The variables have a certain
relationship between them for example; the
amount available with an individual towards
investments would be determined by his
savings rate to a great extent.
 Contd.
► Some of the ratios, which help the financial planner to draw conclusion
are:
 Basic Liquidity Ratio:
Cash / Near Cash
Monthly Expenses
 Liquid Assets to Net worth:
Liquid Assets
Net Worth
 Saving Ratio:
Savings
Gross Income
 Contd.
 Debt to Asset Ratio:
Debt (Total Liabilities)
Total Assets
 Solvency Ratio:
Total Net Worth
Total Assets
 Debt Service Ratio:
Total Amount Debts Repayment
Annual Take home income