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
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