1. Professeur André Farber
Théorie Financière Tableau de financement et planning financier
Professeur André Farber

2. Financial statements and cash flows
Objectives for this session
Leverage: when is it good?
Statement of cash flows
Linking accounting numbers and cash flows
Financial planning
Tfin Cash flows

3. Levers of Performance
Tfin Cash flows

4. Summarized (managerial) balance sheet
Liabilities
Stockholders' equity (SE)
Interest-bearing debt (D)
Assets
Fixed assets (FA)
Working capital requirement (WCR)
Cash (Cash)
FA + WCR + Cash = SE + D
Working capital requirement : definition
+ Accounts receivable + Inventories + Prepaid expenses
- Account payable - Accrued payroll and other expenses
Interest-bearing debt: definition
+ Long-term debt + Current maturities of long term debt + Notes payable to banks
Tfin Cash flows

5. Net Working Capital Net working capital can be understood in two ways:
as an investment to be funded: Current Assets - Current Liabilities
as a source of financing=Stockholders' equity + LT debt - Fixed Assets
Fixed Assets
Stockholder’s equity
Current ratio: a measure of NWC
Current ratio = Current assets / Current liabilites
Net working capital = Current assets - Current liabilites
Current ratio > 1  NWC > 0
Net Working Capital
Long term debt
Current Assets
Current liabilities
Tfin Cash flows

6. Net Working Capital vs Working Capital Requirement
Summarized balance sheet identity:
FA + WCR + CASH = SE + LTD + STD
can be written as:
WCR + (CASH - STD) = (SE + LTD - FA) 
WCR + NLB = NWC
Net Working Capital
Working Capital Requirement
Net Liquid Balance
Tfin Cash flows

7. Return on invested capital
Return on assets (net)= Net income / Total assets
Advantage: fits with DuPont system
ROE = ROA x Equity multiplier
Limitation: Net income = EBIT - Interest expense - Taxes
Depends on capital structure:
1. Interest expense: function of interest-bearing debt
2. Interest expense : tax deductible
Preferred measure: Return on Invested Capital (ROIC)
NB: ROIC = ROA (gross) (1 - Tax rate)
= ROE of a all equity financed firm
Tfin Cash flows

8. ROE = ROIC + (ROAgross - r) (1-Tc) (D/SE)
Financial leverage
Financial leverage magnifies ROE only when ROA (gross) is greater than the interest rate on debt.
Balance sheet: TA = SE + D
Income statement: NI = EBIT - INT- TAX
Interest expense INT = r D (Interest expense = Interest rate x Interest-bearing debt)
Taxes TAX = (EBIT - r D) Tc (Taxes = Taxable income x Tax rate)
Remember : ROIC = ROAgross (1 - Tc)
ROE = ROIC + (ROAgross - r) (1-Tc) (D/SE)
Tfin Cash flows

9. Sources of Cash Inflow and Cash Outflow
Operating Activities Sales of goods and services
Investing Activities Sale of fixed assets Sales of LT financial assets
Financing Activities Issuance of stocks and bonds LT and ST borrowing
CASH
Operating Activities Purchase of supplies Selling, general and administrative expenses Tax expenses
Investing Activities Capital expenditures and acquisitions LT financial investments
Financing Activities Repurchage of stocks and bonds Repayment of debt Dividend payment
CF from operating activities
CF from investing activities
CF from financing activities
Tfin Cash flows

10. Farber.com: a fable Starting a local version of Amazon.com
Initial balance sheet t = 0
Cash 100 Book Equity 100
Operations year 1:
Sell 2 €100 each
Buy 2 € 50 each
Income statement year 1:
Revenue 200
Expenses 100
Net Income 100
But….cash account = What happened?
Tfin Cash flows

11. Farber.com: what happened….
Final balance sheet t = 1
Cash Book Equity 200
Account Receivable 200
Statement of cash flows: reconciles the two views
Direct method: + Cash collected from customers
- Cash payment to suppliers + 100
= Cash flow from operations - 100
Indirect method: Net Income
-Working Capital Requirement + 200
= Cash flow from operations -100
No payment from clients
Initial Capital + Retained Earnings
Tfin Cash flows

12. Farber.com: additional complications
Initial balance sheet t = 0
Cash 100 Book Equity 100
Operations year 1:
Borrow and buy 2d hand €200
Sell 1 €100 each
Buy 2 € 50 each
Income statement year 1:
Revenue 100
Cost of goods sold 50
Depreciation 100
Interest 10
Net Income -60
Final cash account
Straight-line depreciation
2 years
Tfin Cash flows

13. Farber.com: details Final balance sheet t = 1 Cash -10 Book Equity 40
Account Receivable 100 Debt 200
Inventories 50
Fixed Assets 100
Total Total 240
Statement of cash flows: direct method
Cash collection from customers 0 (=REV - AR)
-Cash payment to suppliers 100 (=CGS+ INV)
-Cash paid for interest 10
Cash flow from operating activities -110
Cash flow from investing activities -200 (= FA+Dep)
Cash flow from financing activities +200
Change in cash
Tfin Cash flows

14. Farber.com: statement of cash flows - indirect method
Net Income
+Depreciation
-Working Capital Requirement + 150
= Cash flow from operations -110
Cash flow from investing activities -200
Debt
Cash flow from financing activities +200
Change in cash
Tfin Cash flows

15. Notations Income statement REV Revenue CGS Cost of goods sold
SGA Selling, general and administrative expenses
Dep Depreciation
EBIT Earnings before interest and taxes
Int Interest expenses
TAX Taxes
Tc Tax rate
NI Net income
Balance sheet
FA Fixed assets, net
AR Accounts receivable
INV Inventories
CASH Cash & cash equivalents
SE Equity capital
LTD Long term debt
AP Accounts payable
STD Short-term borrowing
Statement of retained income
DIV Dividendes
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16. Income statement and balance sheet
EBIT = REV - CGS - SGA - Dep
TAX = Tc (EBIT - Int)
NI = EBIT - Int - TAX
Balance sheet equation
FA + AR + INV + CASH = SE + LTD + AP + STD
Working capital requirement: WCR  AR + INV - AP
=(Current assets - CASH) - (Current liabilities - STD)
Summarised balance sheet:
FA + WCR + CASH = SE + D (D = LTD + STD)
Tfin Cash flows

17. Cash flow statement : indirect method
FA + WCR + CASH = SE + D
FA = AQ - Dep
AQ = Acquisitions - Disposals (investing & divesting)
SE = NI - DIV + K
K = New issuance of capital
(NI + Dep - WCR) (AQ) (K + D -DIV) = CASH
Cash flow from operating activities
Cash flow from investing activities
Cash flow from financing activities = + +
Tfin Cash flows

18. Statement of cash flows: direct method
+ Cash collection from customers
- Cash payment to suppliers and employees
- Cash paid for interest
- Cash paid for taxes
= Cash flow from operating activities
+ Cash flow from investing activities
+ Cash flow from financing activity
= CASH
REV - AR
CGS + INV + SGA - AP
Int
TAX
(REV-CGS-SGA-Int-TAX)- WCR
-AQ
K + D - DIV
NI+Dep-WCR
(NI + Dep - WCR) + (-AQ) + (K + D - DIV) = CASH
Tfin Cash flows

19. Free Cash Flow Free Cash Flow = Cash flow from operating activities
+ Cash flow from investing activities
Calculating free cash flows of all equity firm:
Free Cash Flow = EBIT(1-TC) + Dep - WCR - AQ
Statement of cash flows for all-equity firm:
Free Cash Flow = DIV - K + Cash
Tfin Cash flows

20. Financial Forecasting
EBITDA -Depreciation =EBIT
-Taxes
+Net Income
Income Statement
Statement of Cash Flows
CF from operating activities
CF from investing activities
CF from financing activities
Update Balance Sheet
Tfin Cash flows

21. Financial Planning Based on ∆Revenues
Assumptions on key ratios relating Revenues to:
Gross margin: m = EBITDA /Revenues
Working capital requirement: w =  WCR /  Revenues
Net fixed assets: a =  NFA /  Revenues
Financial policy:
Payout ratio p = DIV/Net Income
Depreciation d = Depreciation / Fixed Assets-1
Environment:
Tax rate TC
Cost of debt i
Tfin Cash flows

22. Data Revenues year 0: 2,000 Growth rate year 1: 25%
Balance sheet end year 0
Gross margin: m = 30%
WCR: w = 20%
Net fixed assets: a = 30%
Payout ratio p = 50%
Depreciation d = 10%
Tax rate TC = 40%
Cost of debt i = 10%
Net Fixed Assets
600
Working Capital Requirement
400
Cash
Total Assets
1,000
Book Equity
Debt (financial)
Total Liabilities + Stockholders’ equity
Tfin Cash flows

23. Step 1: Income statement
Year 0
Year 1
Sales
2,000
2,500
Rev-1 (1+g)
EBITDA
750
m × Rev
Depreciation 60
d × NFA-1
EBIT
690
Interests 40
i × D-1
Taxes
260
Net Income
390
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24. Step 2: Statement of Cash Flows
Year 0
Year 1
Net Income
390
From Income Stat.
Depreciation 60
∆WCR
100
w ×  Revenues
CF from operations
350
∆NFA
150
a ×  Revenues
CF from investing
-210
Div
195
p × Net Income
Stock Issues/buy back
Assumption
∆Debt 55
Plug
CF from financing
-140
∆Cash
Tfin Cash flows

25. Step 3: Update balance sheet
Year 0
Year 1
Net Fixed Assets
600
750
NFA-1 + Inv – Dep
Working Capital
400
500
WCR-1 +  WCR
Cash
Cash-1 +  Cash
1,000
1,250
Book Equity
795
BEq-1+SI + NI – DIV
Debt
455
D-1 +  D
Tfin Cash flows

26. The Full Model
Tfin Cash flows

27. Sustainable growth
What growth rate can a company achieve without requirement additional external equity?
 Assets = (a+w)  Revenues
 Assets =  Book Equity +  Debt
=  Book Equity +   Book Equity
= Net Income (1 – Payout)(1 + )
= (Revenues) (Profit Margin)(1-Payout)(1+ )
g =  Revenues / Revenues
= (Profit Margin)(1 – Payout)(1+ ) / (a+w)
Tfin Cash flows

28. Sustainable Growth: example
Back to previous example:
a+w = 0.30
Net Profit margin = 15%
Payout ratio = 50%
 = Debt /  Book Equity = 2/3
g = [15% ( ) (1+2/3) ] / 0.30 = 41.67%
Tfin Cash flows