CASH FLOW ANALYSIS Accrual or Cash basis Accounting
CASH FLOW ANALYSIS Accrual or Cash basis Accounting? Example: A three year business project Purchase of goods on credit in year X 0 100 Selling expenses paid in cash (year X 0) 50 Sales revenue 500 Suppliers due (credit period in months) 12 Customers (credit provided, in months) 24
3 -year results Earnings Cash basis Accrual basis year Χ 0 Χ 1 Χ 2 -50 -100 500 350 0 0 Remarks? • High Profitability • Cash shortage in X 0 & X 1 Total 350
The Importance of adequate cash flows: Shortage of Cash Failure to pay liabilities due Bankruptcy
Cash Items GAS 1. Cash 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 ØOperating activities – CF(OA) ØInvesting activities – CF(IA) ØFinancing 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 Flows a. Operating Activities • Major source of cash • Related to working capital accounts b. Investing Activities • Fixed assets, investments, securities c. 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 0 0 Total
PREPARING THE CF STATEMENT • Direct method ØPossible only internally within the firm ØDetailed information • Indirect method ØFor external users ØIAS 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 of Shareholders’ Equity Appendix and information about: ØChanges in fixed assets, revaluations ØChanges in Equity
Pitfalls in CFS preparation • Transactions affecting two activities, e. g. fixed assets sold: ØEliminating profit or loss from Net Earnings and Operating Activities ØAmount received to be recorded in Investment Activities
CASH FLOW ANALYSIS Operational Activities • Normal source of cash • Efficient Management • OA are positive, except: ØIn high growth rates ØRecession • 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: ØProduction re-engineering ØSupply chain management (JIT) • Expansion of short-term liabilities (? )
CF(OA) Analysis • CF(OA) > Current Liabilities Financial Strength • High CF(OA) / Net Earnings quality • Increase rate of CF(OA) Ørelates 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 Leverage Optimal 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 investments Temptation with high FCF • Low productivity investments ØLuxury assets & spending ØHigh administration or R&D expenses
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