Financial Statement Analysis Martyna Mikołajek M.Sc. Management Financial Facility  Institute of Economic Sciences

Office hours E-mail:martyna.mikolajek@uwr.edu.pl Room:106C Tuesday: 17:00-19:00

Recommended reading FridsonM., Alvarez F.,Financial Statement Analysis: A Practitioner's Guide, John Wiley& Sons, Inc., New York, 2002. KarwowskiM., Accounting and financial reporting, Warsaw School of Economics, 2015. Lecture’s presentations

Cash Flow Analasys

Cash Flow Cash Flow operating activities investment activity financial activity

Operating activities Consequently, when analyzing operational cash flows, you can assess the current cash sufficiency of the company, its solvency (financial liquidity) and compare the accounting profit dimension with its monetary value

Investment activity show what expenses have been incurred in the company to increase the assets of fixed assets, which in the future should enable profit making and cash inflow. It also shows what funds were obtained from the sale of tangible and intangible assets, and what receipts were obtained from the financial assets held. These flows can be used to evaluate the directions of the company's investments and the efficiency achieved from them.

Financial activity including operations to obtain or return financing sources, i.e. equity and external sources (long- and short-term). These flows can be used to assess how the company is financed

You can use the analysis of the cash flow statement to evaluate: the comparative profit of the accountant with the company's cash resources so that you can assess the extent to which the profit has a monetary dimension, sources of cash generation by the company and locations of its allocation. the ability to cover part of the expenses incurred, demand for net working capital and the possibility of financing it.

To remember: You can use the cash flow statement to assess the company's historical financial liquidity (you answer for example how your company handled in the last financial year) and for planning purposes, i.e. you can control the possibilities and consequences of the financial functioning companies in the future (in the form of a cash flow plan).

Interpretation of the cash flow statement (net cash flow) Case Operating activities Investment activity Financial activity Results 1 + 2 - case 1 - the company is characterized by high financial liquidity case 2 - the company covers the costs of the previously incurred liabilities (credits) from the generated funds for operating activities and from the sale of unnecessary assets

Interpretation of the cash flow statement (net cash flow) Case Operating activities Investment activity Financial activity Results 3 + - 4 case 4 - business investment is financed from the core business and borrowed external sources of financing; total flows indicate a further investment opportunity

Interpretation of the cash flow statement (net cash flow) Case Operating activities Investment activity Financial activity Results 5 + - 6 case 5 - situation as in case 4; the scope of investment exceeds the generated cash case 6 - very good situation of the company allows making continuous investments and paying off liabilities (loans)

Interpretation of the cash flow statement (net cash flow) Case Operating activities Investment activity Financial activity Results 7 + - 8 Case 7 - is a signal of impending payment difficulties Case 8 - financing operating activities by incurring further financial liabilities and selling assets; positive total flows indicate a probable continuation of this trend in further periods

Interpretation of the cash flow statement (net cash flow) Case Operating activities Investment activity Financial activity Results 9 - + 10 case 9 - insufficient amount of credits and assets sold to finance the shortage of funds for operating activities case 10 - no further loans are available; repayment of the existing ones is financed from the sale of assets

Interpretation of the cash flow statement (net cash flow) Case Operating activities Investment activity Financial activity Results 11 - + 12 case 11 - situation as in case 1o; insufficient amount of assets needed for repaying loans case 12 - the company is most likely in the development phase; a significant inflow of cash from outside

Interpretation of the cash flow statement (net cash flow) Case Operating activities Investment activity Financial activity Results 13 - + 14 case 13 - situation as above, further co-financing is necessary case 14 - very unfavorable tendency - the possibility of bankruptcy

INITIAL ANALYSIS OF CASH FLOW STATEMENT Let us assume that there are 3 companies - A, B and C. They operate for the same length of time, are in the same sector and employ a similar number of employees. They sell their products on different markets with similar demand. The amount of capital invested in their assets is identical, as well as the level of sales and costs.

INITIAL ANALYSIS OF CASH FLOW STATEMENT In the financial year 2007, these companies achieved the financial results presented below. How we you decide which of the presented companies is better, taking only the above financial figures? The answer is: it is not known until the end. Each company is just as profitable and has the same amount of cash. Item (k PLN) Company A Company B Company C Net Profits 530 Cash balance 1 200

INITIAL ANALYSIS OF CASH FLOW STATEMENT However, if you look at these companies from the point of view of cash flows and their structure, then the situation will appear brighter Item (k PLN) Company A Company B Company C Net Profits 530 Cash balance 1 200 Cash flow: - operating activities - investment activities - financial activities 1200

INITIAL ANALYSIS OF CASH FLOW STATEMENT With this combination, you can be sure that A is the best company, because it generated its cash surplus from operating activities, and therefore had a more favorable monetary than accounting dimension of the financial result.

INITIAL ANALYSIS OF CASH FLOW STATEMENT Company B owes its surplus cash due to the sale of a part of its fixed assets or as a result of non-operational inflows from its financial assets. However, in the operational area, the activity of this company is not very effective. The company C probably took out a loan, which in future periods will cause the outflow of money, because such activities cost (interest, dividends, repayment of loans and borrowings). Please note that if you do not have the capacity to cover your liabilities with operational cash, you may have trouble maintaining financial liquidity in the future.

Operating activity indicators

Operating activity indicators Indicator of the ability to generate operational net flows cash flows from operating activities total cash flows informs us what is the share of cash flows from operating activities in relation to total cash flows.

Operating activity indicators Ratio of relation to operating profit cash flows from operating activities operating profit The high level of the indicator indicates the correct management of cash.

Operating activity indicators Cash Asset Performance Ratio cash flow from operating activities total assets indicators show what is the return on invested assets

Operating activity indicators The rate of reinvestment of equity cash flow from operating activities equity information about how many operational funds were generated from the capital unit invested

Operating activity indicators Amortization rate of operating activity depreciation cash flow from operating activities The analysis should also be made of what part of the operating cash flows results from depreciation. The higher the size of this share, the greater the dependence of the operating result on the factor on which the company has no influence. Therefore, the lowest level of this indicator is desirable.

Indicators of investment activity The second group of indicators, much less important for financial management, was based on cash flows from investing activities. It is first of all necessary to analyze the investment expenses incurred in the period and their relation to total expenditure as well as cash flows from operating activities. It is advisable that investment expenses be as high as possible, and therefore a high level of this ratio is satisfactory.

Indicators of investment activity Capacity indicator for generating net investment flows cash flow from investment activity Total cash flow informs us what is the share of cash flows from investing activities in relation to total cash flows.

Indicators of investment activity Capacity indicator for generating net investment flows Investment expenses Total investments

Indicators of investment activity Investment expenditure coverage ratio cash flow from operating activities investment expenses

Indicators of investment activity Investment expenditure coverage ratio cash flow from operating activities investment expenses

Financial activity indicators

Financial activity indicators The indicator of the ability to generate financial net flows Cash flows from financing activities Total cash flow informs us what is the share of cash flows from financial activities in relation to total cash flows.

Financial activity indicators Sufficiency of financial activity Proceeds from financial activities expenses shows the position of financial activity in the entire flows and the relation of receipts and expenses in this respect.