CASH FLOW ANALYSISAccrual or Cash basis Accounting?

Purchase of goods on credit in year X0 100

Selling expenses paid in cash (year X0) 50

Sales revenue 500

Suppliers due (credit period in months) 12

Customers (credit provided, in months) 24

Example: A three year business project

3-year results

Earnings Χ0 Χ1 Χ2 Total

Cash basis -50 -100 500 350

Accrual basis 350 0 0 350

year

Remarks?

• High Profitability

• Cash shortage in X0 & X1

The Importance of adequate cash flows:

Shortage of Cash

Failure to pay liabilities due

Bankruptcy

Cash Items

GAS

1. Cash

2. Deposits

3. Interest coupons due

IAS

1. Cash

2. Deposits

3. Interest coupons due

4. Cash equivalents

Statement of Cash flows: Importance

• Liquidity • Solvency• Earnings Quality• Financial flexibility• Forecast of future earnings & cashflows

Statement of Cash Flows

• Cash Flows derive (either/or) from Operating activities – CF(OA)Investing activities – CF(IA)Financing activities – CF(FA)

• Analysis of changes in Cash Balance

Algorithm of Cash Flow Statement

OA receipts - payments = CF(OA)

IA receipts - payments = CF(IA)

FA receipts - payments = CF(FA)

=

Net Cash Flow ΧΧΧ

Cash Flowsa. Operating Activities

• Major source of cash• Related to working capital accountsb. Investing Activities• Fixed assets, investments, securitiesc. Financing Activities• Equity, Loans, Dividends, etc

Cash Flows and Business Cycles

entry develop mature decline

OA -3 7 15 8

IA -15 -12 -8 -2

FA 18 5 -7 -6

Total 0 0 0 0

PREPARING THE CF STATEMENT

• Direct methodPossible only internally within the firmDetailed information

• Indirect methodFor external usersIAS No 7

1. Operating activities: direct method

Receipts from• Tax return• Interest income• dividends• customers• advances• receivables

Payments to• suppliers• wages• Interest (debt &

leasing)• tax• expenses• Accounts payables

Operating Activities: Indirect Method

• Net Earnings• + Non Cash Expenses (Depreciation )• - Non Cash Income• - Profit from fixed assets & securities sold• + Loss from fixed assets & securities sold

(continued next)

12

Operating Activities: Indirect Method (continued)

• - Increase in Current Assets• + Decrease in Current Assets• + Increase in Short-term Liabilities• - Decrease in Short-term Liabilities• = Cash Flow from operating activities

13

2. Investing Activities

Receipts from• Fixed assets sold• Investments &

securities sold• Debt provided

installments• Fixed assets

compensations

Payments for• Fixed asset purchase• Investments &

securities purchase• Loans provided• Capitalized interest

expense

3. Financing Activities

Receipts from• Loans• Share capital

increase

Payments for• Share capital refunds• Loan installments• Leasing installments• dividends

Accounting data required for CFS

• Two consecutive Balance Sheets• Income Statement• Statement of Shareholders’ Equity• Appendix and information about:

Changes in fixed assets, revaluationsChanges in Equity

Pitfalls in CFS preparation

• Transactions affecting two activities, e.g. fixed assets sold:Eliminating profit or loss from Net

Earnings and Operating ActivitiesAmount received to be recorded in

Investment Activities

CASH FLOW ANALYSIS

Operational Activities• Normal source of cash• Efficient Management• OA are positive, except:

In high growth ratesRecession

• Deficit is covered by CF from IA or FA

Methods of Analysis for CF(OA)

• In relation to liquidity & capital structure ratios

• In relation to other similar firms• Regularity - Trend• In relation to the life cycle of the

product or the firm

Management of CF(OA)

Increase with:• Strict credit policy to customers• Reduced inventories held by:

Production re-engineeringSupply chain management (JIT)

• Expansion of short-term liabilities (?)

CF(OA) Analysis

• CF(OA) > Current Liabilities Financial Strength

• High CF(OA) / Net Earnings Earnings quality

• Increase rate of CF(OA)relates to share value & risk

• Unsuitable for Return measurement

Cash Flow from Investing Activities

• Reveals growth or shrinkage• Affect on future earnings & CF(OA)• Consider replacement of old fixed assets• Consider maturity of securities• Consider strategic investments: (business

concentration or expansion?)• Over expansion may threat solvency

Cash Flow from Financing Activities

Benefits from Debt capital:• Tax reduction from interest expense• Financial LeverageOptimal Relationship of Equity & Debt• ROE > ROTA• Loan repayment with Free Cash Flows

FREE CASH FLOWS – (FCF)

ορισμός:• FCF=CF(OA) – capital maintenance – loan

repayment• Available cash flow above necessary needs• Accurate calculation of CFC internally only

Uses of Free Cash Flows

• Dividend payment• Extended investmentsTemptation with high FCF• Low productivity investments

Luxury assets & spendingHigh administration or R&D expenses