Cash Flow Management

Dr.Hiren Maniar

7-1

Cash Flow
Cash
Life

is King

blood of business

Cash

flow related financial reports are

most important (even more important
than Income Statement)

Understand
7-2

cash versus accrual

Cash Flow
Payroll
Inventory
Utilities
Rent
Taxes
Interests
Loans
Etc.

Products / Services
Cash out

Business

Customers
Cash In

Equity and/or
Debt financing
7-3

Cash Flows
Cash Outflows
Initial Investment
Working Capital Inv.
Repairs & Maint.
Inc. Man. & Op Costs
Interest and Loan Pmt
Income Taxes
7-4

Cash Inflows
Incremental Revenue
Cost Savings
Allowed Tax Credits
Salvage Value
Working Cap Release
ST & LT Loans

Cash Flow Elements

Recovery of Working Capital

Operating Cash Inflows

Salvage Value

Borrowed Funds
0

Operating Cash Outflows

Investment in Assets
and Working Capital

Loan Repayment

Net cash flow = Cash inflow - cash outflow

7-5

The Cash Flow Cycle

Order
Goods

Day 1

Receive
Goods

15
14

Deliver
Goods

Sell
Goods*

Pay
Invoice

40
25

Send
Invoice

Customer
Pays**

280

218 221 230

178

50

Cash Flow Cycle = 240 days

* Based on Average Inventory Turnover: ** Based on Average Collection Period:

365 days
= 178 days
2.05 times/year

7-6

365 days
= 50 days
7.31 times/year

Cash Flow Definitions

Operating

Cash Flow

EBITDA = EBIT + Dep/Amort

or, EBIT(1 t) + Dep/Amort
Free

Cash Flow =

EBIT(1 t) + Dep/Amort - Change in

NWC - Capital Spending
7-7

Free Cash Flow

Dividends

are the cash flows actually paid to

stockholders. Free cash flows are the cash flows
available for distribution.

Free

Cash Flow (FCF) is the amount of cash flow

available to debt and equity holders after meeting all
operating needs and paying for its net fixed asset
investments (NFAI) and net current asset investments
(NCAI).
FCF = OCF NFAI - NCAI
NFAI = Change in net fixed assets + Depreciation
NCAI = Change in CA Change in A/P and Accruals

7-8

Profitability and cash flow

When Cash In is consistently larger than

Cash out
= Profitable and sustainable business

If and when Cash goes out faster than

Cash gets In, business could bankrupt
even when profitable

7-9

Reasons for Cash Flow Problems

Difficulty

in collecting receivables

Seasonality

of sales

Unexpected

variation in sales

Policies

on how payments are made to

suppliers)

Large

expenditures up front for customer

projects

Capital
7-10

projects

Ineffective

inventory management

Cash Flow Management

Assure

cash is available when needed

Manage

timing of cash in and cash out

Manage

working capital

Minimize

7-11

expenditures

Know

how business get and uses its cash

Know

how growth affects cash needs

Purposes of the Cash Flow Statement

The cash flow statement is designed to fulfill the following:

7-12

Predict future cash flows

Determine the ability to pay dividends plus interest and

principal

Show the relationship of net income to cash flow

How much cash was generated by operating activities?

What were the new financing activities during the period?

How much of new financing was internally generated or

was from new debt or equity?

How was debt financed and paid?

Let us understand Cash Flow

Statement with example

7-13

Sources and
Uses Statement
The letters labeling
the boxes stand for
Uses, Sources,
Assets, and
Liabilities (broadly
defined). The pluses
(minuses) indicate
increases
(decreases) in
assets or liabilities.
7-14

Sources / Uses of Cash

USES

SOURCES
Profitable
Sales

operations

of fixed assets

Long-term
Issues

of shares

Decrease

capital
7-15

borrowing
in working

Loss-making
Purchase

operations

of fixed

assets
Repayment

of loans

Payment

of dividends

Increase

in working

capital

BWs Determination
of Sources and Uses
Assets
Cash and C.E.
Acct. Rec.
Inventories
Prepaid Exp
Accum Tax Prepay
Current Assets
Fixed Assets (@Cost)
Less: Acc. Depr.
Net Fix. Assets
Investment, LT
Other Assets, LT
Total Assets
7-16

2007
$

90
394
696
5
10
1,195
1030
(329)
701
50
223
2,169

2006
$

100
410
616
5
9
1,140
930
(299)
631
50
223
2,044

+/-

S/U

S
S
U
-U
N/A
N/A
N/A
U
---

BWs Determination
of Sources and Uses
Assets
Cash and C.E.
Acct. Rec.
Inventories
Prepaid Exp
Accum Tax Prepay
Current Assets
Fixed Assets (@Cost)
Less: Acc. Depr.
Net Fix. Assets
Investment, LT
Other Assets, LT
Total Assets
7-17

2007
$

90
394
696
5
10
1,195
1030
(329)
701
50
223
2,169

2006
$

100
410
616
5
9
1,140
930
(299)
631
50
223
2,044

+/$10
16
80
1

70

S/U
S
S
U
-U
N/A
N/A
N/A
U
---

BWs Determination
of Sources and Uses
Liabilities and Equity
Notes Payable
Acct. Payable
Accrued Taxes
Other Accrued Liab.
Current Liab.
Long-Term Debt
Shareholders Equity
Com. Stock ($1 par)
Add Pd in Capital
Retained Earnings
Total Equity
7-18 Total Liab/Equity

2007
$

290
94
16
100
500
530

200
729
210
$ 1,139
$ 2,169

2006
$

$
$

295
94
16
100
505
453
200
729
157
1086
2,044

+/-

S/U

U
---N/A
S

--S
N/A

BWs Determination
of Sources and Uses
Liabilities and Equity
Notes Payable
Acct. Payable
Accrued Taxes
Other Accrued Liab.
Current Liab.
Long-Term Debt
Shareholders Equity
Com. Stock ($1 par)
Add Pd in Capital
Retained Earnings
Total Equity
7-19 Total Liab/Equity

2007
$

290
94
16
100
500
530

200
729
210
$ 1,139
$ 2,169

2006
$

$
$

295
94
16
100
505
453
200
729
157
1086
2,044

+/$ 5

77

53

S/U
U
---N/A
S
--S
N/A

Basic Sources
and Uses Statement
SOURCES
Increase, Retained Earnings
(S-17)
Decrease, Accounts Receivable (S-15)
Increase, Long-Term Debt
(S-17)
Decrease, Cash + Cash Equivalents (S-15)
USES
Increase, Inventories
(S-15)
Increase, Accum Tax Prepay
(S-15)
Decrease, Notes Payable
(S-17)
Increase, Net Fixed Assets
(S-15)
7-20

$ 53
16
77
10
$156
$80
1
5
70
$156

Adjusting the Basic

Sources and Uses Statement
The following three slides are
Basket Wonders Balance Sheet
and Income Statement
This information will be needed
to adjust the basic Sources
and Uses Statement.
7-21

Basket Wonders Balance

Sheet (Asset Side) refer (S-15)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007
Cash and C.E.
$
90
Acct. Rec.c
394
Inventories
696
5
Prepaid Exp d
Accum Tax Prepay
10
Current Assetse $1,195
Fixed Assets (@Cost)f 1030
(329)
Less: Acc. Depr. g
Net Fix. Assets $ 701
Investment, LT
50
Other Assets, LT
223
Total Assets b $2,169
7-22

a. How the firm stands on

a specific date.
b. What BW owned.
c. Amounts owed by
customers.
d. Future expense items
already paid.
e. Cash/likely convertible
to cash within 1 year.
f. Original amount paid.
g. Acc. deductions for
wear and tear.

Basket Wonders Balance

Sheet (Liability Side) refer (S-16)
Basket Wonders Balance Sheet (thousands) Dec. 31, 2007
Notes Payable
$ 290
Acct. Payablec
94
16
Accrued Taxes d
Other Accrued Liab. d
100
Current Liab. e $ 500
Long-Term Debt f
530
Shareholders Equity
Com. Stock ($1 par) g
200
Add Pd in Capital g
729
Retained Earnings h
210
Total Equity
$1,139
7-23

Total Liab/Equitya,b $2,169

a. Note, Assets =
Liabilities + Equity.
b. What BW owed and
ownership position.
c. Owed to suppliers for
goods and services.
d. Unpaid wages,
salaries, etc.
e. Debts payable < 1 year.
f. Debts payable > 1 year.
g. Original investment.
h. Earnings reinvested.

Basket Wonders
Income Statement
Basket Wonders Statement of Earnings (in thousands)
for Year Ending December 31, 2007
Net Sales
$ 2,211
Cost of Goods Sold b 1,599
Gross Profit $
612
SG&A Expenses c
402
EBITd
$
210
Interest Expensee
59
EBT f
$
151
Income Taxes
60
EATg
$
91
Cash Dividends
38
Increase in RE
$
53
7-24

a. Measures profitability
over a time period.
b. Received, or receivable,
from customers.
c. Sales comm., adv.,
officers salaries, etc.
d. Operating income.
e. Cost of borrowed funds.
f. Taxable income.
g. Amount earned for
shareholders.

Adjusting the Basic

Sources and Uses Statement
Recognize Profits and Dividends
Change in retained earnings is composed
of profits and dividends.

Source:

Net Profit (S-22)

Less Use: Cash Dividends

(Net) Source: Incr., R.E.
7-25

$91
(S-22)

38
$53

Adjusting the Basic

Sources and Uses Statement
Recognize Depreciation and Gross
Changes in Fixed Assets
Change in net fixed assets is composed of
depreciation and fixed assets.

Source: Depreciation (S-14) $ 30

Less Use: Add. to F.A. (S-14)
100
(Net) Use:
Incr., Net F.A. $ 70
7-26

Sources and Uses

Statement (Sources Side)
SOURCES
Funds provided by operations
Net Profit
(S-22)
Depreciation
(S-14)
Decrease, Accounts Receivable (S-18)
Increase, Long-Term Debt
(S-18)
Decrease, Cash + Cash Equivalents (S-18)

$ 91
30
16
77
10
$224

7-27

Sources and Uses

Statement (Uses Side)
USES
Dividends
(S-22)
Additions to fixed assets (S-14)

$ 38
100

Increase, Inventories
(S-18)
Increase, Accum. Tax Prepay (S-18)
Decrease, Notes Payable (S-18)

80
1
5
$224

7-28

Statement of Cash Flows

A summary of a firms payments
during a period of time.
This statement reports cash inflows
and outflows based on the firms
operating activities,
investing activities, and
7-29

financing activities.

Statement of Cash Flows

Cash Flow from Operating Activities
Shows impact of transactions not
defined as investing or financing
activities.
These

cash flows are generally the cash

effects of transactions that enter into the
determination of net income.

7-30

Cash Flow From

Operating Activities
Cash Inflows
From sales of goods or services
From interest and dividend income
Cash Outflows
To pay suppliers for inventory
To pay employees for services
To pay lenders (interest)
To pay government for taxes
To pay other suppliers for other
operating expenses
7-31

Cash Flow From

Operating Activities
It would seem more logical to classify
interest and dividend income as an
investing inflow, while interest paid
certainly looks like a financing
outflow.
But, the GAAP Standards classified these
items as operating flows.

7-32

Statement of Cash Flows

Cash Flow from Investing Activities
Shows impact of buying and selling
fixed assets and debt or equity
securities of other entities.
Cash Flow from Financing Activities
Shows impact of all cash transactions
with shareholders and the borrowing
and repaying transactions with lenders.
7-33

Cash Flow From

Investing Activities
Cash Inflows
From sale of fixed assets (property, plant,
equipment)
From sale of debt or equity securities (other
than common equity) of other entities
Cash Outflows
To acquire fixed assets (property, plant,
equipment)
To purchase debt or equity securities (other
than common equity) of other entities
7-34

Cash Flow From

Financing Activities
Cash Inflows
From borrowing
From the sale of the firms own equity
securities
Cash Outflows
To repay amounts borrowed
To repurchase the firms own equity
securities
To pay shareholders dividends
7-35

7-36

Determination of Cash Flows From Operating

Activities
Direct Method
Income

Statement items are converted to

cash flows individually

Indirect Method
Net

7-37

income or loss is adjusted for

accruals such as accounts receivable and
payable, and for non-cash expenses such
as depreciation reconciliation of the
accrual based and cash based accounting

Comparison of Methods

Direct method of presentation calculates cash flow

from operations by subtracting cash disbursements to
supplies, employees, and others from cash receipts
from customers.
The indirect method calculates cash flow from
operations by adjusting net income for non-cash
revenues and expenses.
Most firms present their cash flows using the indirect
method.

Only operating activities section is different

between the methods, investing and financing
7-38
sections are the same.

Indirect Method -Statement of Cash Flows

Cash Flow from Operating Activities
Net Income
(S-22)
$ 91
Depreciation
(S-14)
30
Decrease, accounts receivable (S-18)
16
Increase, inventories
(S-18)
( 80)
Increase, accum. tax prepay (S-18)
( 1)
Net cash provided (used) by
operating activities
7-39

$ 56

Indirect Method -Statement of Cash Flows

Cash Flow from Investing Activities
Additions to Fixed Assets (S-14)
Net cash provided (used) by
investing activities

7-40

$(100)

$(100)

Indirect Method -Statement of Cash Flows

Cash Flow from Financing Activities

7-41

Increase, notes payable (S-18)

Increase, long-term debt (S-18)
Dividends paid
(S-22)

$ ( 5)
77
( 38)

Net cash provided (used) by

financing activities

$ 34

Indirect Method -Statement of Cash Flows

Increase (decrease) in cash
and cash equivalents (S-15)
$ ( 10)
Cash and cash equivalents, 2006
100
Cash and cash equivalents, 2007 $ 90
Supplemental cash flow disclosures
Interest paid
(S-22)
$
Taxes paid
(S-22)
7-42

59
60

Direct Method -Statement of Cash Flows

Cash Flow from Operating Activities
Cash received from customersa
Cash paid to suppliers and
employeesb
Interest paid
Taxes paidc
Net cash provided (used) by
operating activities
a, b, c

7-43

$2,227
(2,051)
( 59)
( 61)
$

56

See Worksheet on next slide for calculation

Worksheet for Preparing

Operating Activities Section
(a)
+(-)

Sales
(S-22)
Decrease (increase) in AR (S-18)
Cash received from customers

$2,211
16
$2,227

COGS - Depreciation + SGA (1599-30+402)

((S-22) , (S-14) , (S-22) )
$1,971
+(-) Increase (decrease) in inventory (S-18)
80
Cash paid to suppliers and employees $2,051
(c)
Income taxes (federal / state)
(S-22) $ 60
+(-) Incr (Decr) in accum. tax prepay (S-18)
1
Taxes paid
$ 61
(b)

7-44

Direct Method -Statement of Cash Flows

Cash Flow from Investing Activities
Additions to Fixed Assets (S-14)
Net cash provided (used) by
investing activities

7-45

$(100)

$(100)

Direct Method -Statement of Cash Flows

Cash Flow from Financing Activities

7-46

Decrease, notes payable (S-18)

Increase, long-term debt (S-18)
Dividends paid
(S-22)

$ ( 5)
77
( 38)

Net cash provided (used) by

financing activities

$ 34

Direct Method -Statement of Cash Flows

Increase (decrease) in cash
and cash equivalents
Cash and cash equivalents, 2006
Cash and cash equivalents, 2007

$ ( 10)
100
$ 90

Supplemental cash flow disclosures

7-47

Net Income (EAT)

Depreciation
Decrease, accounts receivable
Increase, inventories
Increase, accum. tax prepay
Net cash provided (used) by
operating activities

91
30
16
( 80)
( 1)

56

WORDS OF WISDOM
Cash flow analysis is a method of
worrying before you spend your
money instead of afterwards.

7-48

Thank Q
7-49