1. Cash Flow Analysis Nicole Mahfoud Estefania Rodriguez

2. Cash Flow Analysis An objective of financial analysis is to measure a company’s operating performance and financial condition.

3. Cash flow analysis The choices available in the accrual accounting system make it difficult to compare companies' performances. Cash flows provide the financial analyst with a way of transforming net income based on an accrual system for it to be compared easier.

4. Difficulties with measuring cash flows The primary difficulty with measuring cash flow is that it is a flow: Cash flows into the company (cash inflows) and cash flow out of the company (cash outflows).

5. Difficulties with measuring cash flows A simple method of calculating cash flow requires adding noncash expenses (for example, depreciation) to the reported net income amount to arrive at an approximation of cash flow, earning before depreciation and amortization, or EBDA. EBDA = net income + Depreciation and amortization

6. Difficulties with measuring cash flows The problem with this measure is that it ignores the many other sources and uses of cash during the period, cash that, for many companies, are significant.

7. Difficulties with measuring cash flows Another estimate of cash flow that is simple to calculate is earnings before interest, taxes, depreciation, and amortization, EBITDA. It is calculated: EBITDA = Operating income, EBIT + interest expenses + depreciation and amortization

8. Difficulties with measuring cash flows EBITDA is useful not only for its simplicity, but because it allows us to compare companies based on operations, without considering how companies choose to finance their assets.

9. Cash Flows and Statement of cash flows Over time, many companies began presenting information using the cash concept, which is a more detailed presentation of the cash flows provided by operations, investing and financing activities, which are the categories of cash flows.

10. Cash Flows and Statement of cash flows The reporting company may report the cash flows from the operating activities on the statement cash flows using either the direct method (reporting all cash flow inflows and outflows) or the indirect method, starting with net income and making adjustments for depreciation and other noncash expenses and for changes in the working capital accounts.

11. The direct method provides more information about the sources of the company’s cash flows. Though it is recommended, but it is also the most difficult for the reporting company to prepare, as a result, most companies report cash flows from operations using the indirect method. Cash Flows and Statement of cash flows

12. Looking at the relation among the three cash flows in a statement gives the analyst a sense of the activities of the company. For example: A young, fast growing company may have Negative cash flows from operations But, Positive cash flows from financing activities. Cash Flows and Statement of cash flows

13. Free Cash Flows Free cash flow (FCF), an alternative measure, was developed by Michael Jensen. FCF is a measure of financial performance calculated as operating cash flow minus capital expenditures.

14. Free Cash Flows Free Cash flow is also known as Free cash flow to equity, FCFE. FCFE = Cash flow from operations – capital expenditures. IF WE ADD AFTER TAX INTEREST: FCFF FCFE + After tax interest = FCFF (Free cash floe to the firm. The theory of FCF was developed to explain behaviors of the companies that could not be explained by existing economic theories.

15. Calculating Free Cash Flow There is no correct method of calculating free cash flow and different analyst may arrive at different estimates of free cash flow for a company. Because the amount of capital expenditures necessary to maintain the business at its current rate is generally not known. Most analyst estimate free cash flow by assuming that all capital expenditures are necessary for the maintenance of the current growth of the company.

16. Example This is an example of some of the variations that you will se in the free cash flow calculation. Because there is no one, right way to calculate free cash flow, for a given company you may see different values.

17. Net free cash flow Is a free cash flow less interest and other financing costs, and taxes. In this approach, free cash flow is defined as earnings before depreciation, interest and taxes, less capital expenditures. Further, cash taxes are deducted to arrive at net free cash flow. The difference between NFCF and free cash flow above is that: The financing expenses- interest and, in some case dividends- are deducted. NFCF does NOT consider changes in working capital in the analysis

19. The usefulness of cash flows in financial analysis An analysis of cash flows, and the sources of cash flows can reveal information to the analyst, including: The sources of financing the company’s capital spending. The company’s dependence on borrowing. The quality of earnings.

20. Ratio Analysis This ratio gives the analyst information about the financial flexibility of the company and is particulary useful for capital- intensive firms and utilities This ratio gives a measure of a company’s ability to meet maturing debt obligations.

21. Patterns of cash flows Cash flow information may help analyst identify companies that may encounter financial difficulties, they base their analysis on: Healthy companies tend to have a relative stable relations among the cash flows for three sources, correcting any given year’s deviation from their norm within one year. Unhealthy companies exhibit cash declining cash flow from operations and financing and declining cash flows for investment 1 or 2 year prior bankrupt. Unhealthy companies tend to spend more cash flows to financing sources than they bring during the year prior to bankrupt Michael T. Dugan and William D. Samson

22. Company performance Cash flow and free cash flow, are often used as metrics to gauge whether the financial performance of a company is sustainable. A company that is able to consistently generate cash flow in excess of capital expenditures is considered to have the flexibility to expand as new investment opportunities arise and/or to pay additional dividend to shareholders

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